Money & Banking

Private banks’ average lending rate on new loans move up nearly 40 bps in October

Radhika Merwin Chennai | Updated on November 27, 2020 Published on November 27, 2020

With the RBI’s next policy meet around the corner and the market debating over the possibility of further rate cuts, the sudden jump in average lending rate of private banks may need some attention.

According to the latest data released by the RBI on banks’ lending rates, the weighted average lending rate on fresh loans for private banks have gone up by 36 bps in October to 9.02 per cent from 8.66 per cent in September. With the lending rates on new loans for foreign banks too moving up by about 30 bps, the overall weighted average lending rate on fresh loans for all banks has gone up by about 9 bps in October.

The RBI had last cut its key policy repo rate in May by 40 bps to 4 per cent and since then held rates owing to rise in inflation. While banks’ tardiness to cut lending rates sharply may be understandable — as the RBI is expected to remain in a pause mode in the near term — lending rates moving up at a time when the economy is starting to recover could be worrisome.

Short term aberrations aside, what could explain the increase in lending rates could be the higher risk premium that certain banks are assigning for certain loans, given the weak credit environment. In July too, the average lending rates of private banks (on new loans) had seen a 38 bps increase over June.

Aside from the marginal uptick in September (by 5 bps), average lending rate on fresh loans for PSU banks has been steadily falling since January. As of October, the average lending rate for PSU Banks stood at 7.98 per cent, against 9.02 per cent for private banks.


Varied actions

The cumulative 250 bps repo rate cut since January 2019 (135 bps in 2019 and 115 in 2020 so far), has indeed aided borrowers. Lending rates have fallen substantially over the past two years, along with the reduction in policy repo rate. But the key issue for borrowers has always been banks’ tardiness in passing on the RBI’s rate cut to them in its entirety.

For instance, the weighted average lending rate on fresh loans fell by just 68 bps against RBI’s 135 bps reduction in repo rate in 2019. Average lending rates on outstanding loans fell by a meagre 13 bps in 2019, indicative of how the issue of transmission is more pronounced in older loans.

To iron out the chinks in the MCLR structure, the RBI had mandated banks to link loans to external benchmarks such as repo rate from October last year. This has helped bring down lending rates at a faster pace. From January to October this year, weighted average lending rates on fresh loans has fallen by about 98 bps (against repo rate reduction of 115 bps). While this is heartening, the extent of reduction in lending rates still varies widely across banks. For instance, in case of PSU Banks average lending rates for fresh loans has fallen by just 87 bps so far in 2020. The lower pace of disbursement of fresh loans at PSBs may be one reason for this.

Despite the adhoc increase in lending rates in some months, average lending rate on new loans for private banks has fallen by a sharper 117 bps between January and October this year.

Why the increase?

The final lending rate is a function of the benchmark rate and the spread that banks charge over it. Banks decide the spread over the external benchmark, depending on their assessment of the borrowers’ credit risk premium. Hence the final lending rate can go up or down even if there is no change in benchmark rate, depending on the spread that banks charge.

Given the lingering uncertainty in the business environment and higher credit risk, it is possible that few private banks are charging higher spread on certain loans. This could be one reason for the lending rates to increase in October.

A relatively higher cost of deposits may also offer lower leeway to reduce lending rates for few private banks. PSU banks’ 3-5 year deposits currently offer 4.9-5.25 per cent, while for private banks it ranges between five and seven per cent. Higher lending activity by private banks in certain high-yielding loan segments, could also be one reason for the overall lending rates to inch up.

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Published on November 27, 2020
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