Policy rate cuts transmission higher for depositors than borrowers

Interest rates for borrowers and depositors have been on a downward march since February 2019, when the current easing cycle first began. But data from the RBI suggest that while the reduction in policy rates has not been entirely passed on to borrowers, depositors have seen deeper cuts on their returns, with the transmission being faster for them.

With the rate cycle expected to turn sooner than later, further transmission to borrowers seem unlikely, while depositors may begin to see higher returns when policy rates move up.

Further drop unlikely

While repo rate was cumulatively cut by 250 basis points (bps) since February 2019, the weighted average lending rates (WALR) on all outstanding bank loans fell by just 118 bps, until August 2021.

However, RBI’s sector-wise data on WALR (outstanding loans) reveal faster transmission of rate cuts in the lending rates for large industries, infrastructure, trade, and professional services — in the range of 181 to 226 bps, over March 2019 to August 2021. On the other hand, the WALR on retail loans such as housing, vehicle and education loans dropped only by 98 to 185 bps. MSMEs also saw a fall of just 182 bps in their WALR (outstanding loans).

In the past, the transmission of policy rate cuts to lending rates have been more sluggish, thanks to the banks’ reliance on internal benchmarks, that is, their own cost of funds. However, the RBI, in 2019-20, mandated banks to move to an external benchmark for select loan categories. These include all new floating rate personal or retail loans and floating rate loans to micro, medium and small enterprises (MSMEs).

Following this, the share of external benchmark-linked loans in total outstanding floating rate bank loans increased from 2.4 per cent in September 2019 to 32 per cent in June 2021. Owing to this, the WALR on fresh rupee loans offered by banks, dropped by 190 bps (vs 118 bps on an overall level) during February 2019 to August 2021. However, with Marginal Cost of Funds Based Lending Rate (MCLR) based loans still accounting for a lion’s share of 60 per cent of overall floating rate loans, the transmission of rate cuts is slower on an outstanding loans level (118bps as discussed above).

Much of the funds that banks lend to borrowers comes from depositors – including low cost Current Accounts and Saving Accounts (CASA). On the other hand, banks’ reliance on RBI’s repo operations is as low as 10 per cent. The current share of MCLR-based loans – 60 per cent of outstanding floating rate loans – makes it more difficult for banks to pass on the repo rate cuts to borrowers.

Hence, industry experts feel much of the drop in interest rates has already been given effect to and a further drop is highly unlikely.

Upturn to help depositors

With inflation data in the US for October coming in at a 31-year high of 6.2 per cent, markets in the US are now pricing in two rate hikes next year as against zero expectations of a hike a few months back.

In India, too, core inflation continues to remain sticky. Domestic inflation apart, the RBI may also have to consider interest rate hikes to defend the domestic currency. Given these factors, a turn in the interest rate cycle in India is expected sooner than later. This may be good news for depositors as, compared with lending rates, deposit rates move faster with change in policy rates. In the ongoing down cycle, weighted average domestic term deposit rates were slashed by 180 bps from February 2019 to August 2021, which is higher than the fall in lending rates during the same period.

Basis the data compiled by Bankbazaar.com on interest rates offered on bank deposits, the rate reduction of deposits of private banks was in the range of 75 to 285 bps on deposits with a tenure of less than two years compared with just 110 to 160 bps decline in rates offered by public sector banks, for similar tenures, during the same period.

Deposit rates of small finance banks too fell sharply — in the range of 175 to 275 bps — for deposits with tenure of less than two years.

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