COMMENT. RBI holds rates, but for borrowers, lending rates have already started inching up

With the Centre slipping on its fiscal deficit target and inflation on the rise, it is only a matter of time before the RBI starts to hike rates. While it has chosen to keep rates unchanged in its latest policy, for borrowers, the party has been long over. For one, yields on the 10-year G-Sec have moved up sharply by 60-70 bps since the RBI’s December policy. Also, given that it was the excess liquidity in the system post-demonetisation that drove steep cuts in deposit and lending rates by banks, the gradual tightening of liquidity will lead to a quicker and sharper rise in rates in the coming months. A few banks have already started hiking their benchmark lending rates, much ahead of any policy move by the RBI.

If borrowers gained from the new MCLR structure that led to quicker transmission of policy rate actions over the past two years, it’s time they braced themselves for a faster rise in lending rates.

Liquidity playing its part

While the RBI embarked on its rate easing cycle in January 2015, lending rate cuts lagged the fall in policy repo rate -- at which banks borrow short-term funds from the RBI -- as well as banks’ deposit rates. Between January 2015 and October 2016, while the RBI had cut the repo rate by 175 bps, lending rates had fallen by 80-90 bps, even as deposit rates had declined by a notable 120 bps. While the introduction of MCLR framework -- where banks have to calculate their cost of funds based on the latest rates offered on deposits -- did help, it did not address the transmission issue entirely. In fact, much of the fall in lending rates was triggered post-demonetisation, due to the surplus liquidity. Taking the cue from SBI that slashed its benchmark lending rate by 90 basis points in January last year, other banks too cut their lending rates by 70-80 basis points.

Since then banks have reduced lending rates by 20-30 bps, but post the RBI’s last rate cut in August 2017, banks have only tinkered with lending rates, trimming them by 10-15 basis points.

As it were, the party appears long over for borrowers, with lending rates already starting to inch up in a few banks. In fact, the writing was already on the wall, when SBI cut its savings deposit rate in July last year, to tide over its cost pressure. We have been indicating over the past few months, that borrowers need to brace themselves for sharp hikes in lending rates.

Already on the rise

The benefits in the form of surplus inflows post-demonetisation have been waning for sometime now. Notably, it has impacted rates on bulk deposits on which banks use their discretion to set rates. These deposits earned lower interest rates than retail deposits post-demonetisation. With liquidity gradually draining out, rates on such deposits have been inching up since mid of last year. Given that the MCLR uses the latest rates on deposits for computation, this was exerting upward pressure on the MCLR. Instead of raising the MCLR, banks trimmed rates on savings deposits instead (taking a cue from SBI).

Hence it was only a matter of time before banks started to increase their benchmark lending rates. A few banks have increased their MCLR without waiting for the RBI to hike its policy rate. Dena Bank, Kotak and Axis Bank increased their one-year MCLR by 5 bps recently. HDFC Bank and IndusInd have increased their MCLR by 10 basis points in the past one month. For YES Bank, its one-year MCLR has gone up by a notable 30 bps from 8.85 per cent in December 2017 to 9.15 per cent in February 2018.

With deposit rates moving up by 10-30 bps in some banks across some tenures, lending rates are likely to increase in the coming months. SBI recently hiked its rates on bulk deposits (Rs 1 crore to 10 crore) by 50-140 bps across tenures, signally more such increases across banks. This will lead to significant lending rate increases in the coming months.

Double-edged sword

Rate increases are likely to pinch borrowers more this time, thanks to the MCLR framework. This is because changes in deposit rates will immediately reflect on banks’ cost of funds under MCLR, leading to a much sharper and quicker rise in lending rates. As such, banks have been more nimble in passing on rate hikes to borrowers in the past.

There is one silver lining though -- reset clauses under the MCLR structure. Unlike under the base rate system, where a revision in base rate was immediately reflected in lending rates of all loans benchmarked against it, under the MCLR-based pricing, lending rates are reset only at intervals corresponding to the tenure of the MCLR. Hence, in the case of home loans, which are benchmarked against the one-year MCLR, lending rates will only be reset every year.

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