Comment. Will an RBI rate cut lower lending rates?

About a month back, HDFC Bank shook up the banking sector with a steep 35-basis-point cut in its base rate. Until then, banks had lowered their base rates, or minimum lending rates, by 25-30 basis points (bps), far lower than the 75 bps cut in RBI’s key policy repo rate since January.

By reducing its base rate to 9.35 per cent, HDFC Bank has almost entirely passed on the RBI’s rate action now.

But surprisingly, other leading banks have not been in a hurry to play catch-up. Historically, SBI, ICICI Bank and HDFC Bank have offered the best lending rates and their rate actions have more or less moved in tandem.

But this time around, both SBI and ICICI Bank chose to adopt a wait-and-watch approach in spite of the yawning gap in their base rates vis-à-vis HDFC Bank’s. Both SBI and ICICI Bank have kept their base rates unchanged at 9.7 per cent.

Now, all eyes are on the RBI’s rate action today. With the US Fed deferring its rate hike and domestic inflation moving lower — well below the RBI’s targeted rate for January 2016 — most expect a 25 bps rate cut.

But going by banks’ actions in the last six-nine months, the RBI’s rate cut may not ensure immediate lowering of lending rates.

The RBI will likely nudge banks once again to speed up transmission of lower policy rates to borrowers.

The transmission of RBI’s rate action has always come with a lag with respect to borrowers. One of the main reasons for this has been that banks source only a small portion of their funds at the repo rate and hence any change in the latter has minimal impact on banks’ cost of funds.

Banks mainly rely on longer-term deposits. Hence, only 50-60 per cent of banks’ funding gets re-priced.

This apart, the poor performance of most public sector banks — that constitute three-fourths of bank lending — has also slowed transmission.

Their margins have been under pressure due to muted credit growth and weak asset or loan quality. This leaves them with less leeway to lower loan rates, despite a sharp 1-1.25-percentage-point fall in their deposit rates.

While retail borrowers have not benefited (as much) from the RBI’s rate action, companies appear to have made the most of the bond market.

Many of them have funded their working capital needs by issuing commercial papers (CPs).

Since January, the rates on the three-month and 12-month CPs have fallen by 70-75 basis points. Increasing issuances of corporate bonds and CPs indicate that companies have been tapping the bond market for funds, as rates have fallen sharper there than in banks’ lending rates.

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