SLATE. All you wanted to know about repo-linked deposit and lending rates

As everyone cheered the 35-basis point repo rate cut in last week’s monetary policy meeting, were you wondering why such cuts never seem to trickle down to you? The RBI has been worried too and has been looking at various ways in which banks can be made to transmit repo rate cuts to depositors and borrowers. One idea that banks have come up with is repo-linked deposit and lending rates.

Starting from May this year, India’s largest bank SBI announced that it was linking the interest rate on its savings bank accounts as well as short-term loans to RBI’s repo rate. Effective May 1, SBI savings bank accounts with balances of over ₹1 lakh would earn interest at the repo rate minus 2.75 per cent. Similarly, the floor rates it charges on overdrafts and cash credits of over ₹1 lakh, would be pegged 2.25 per cent above the repo rate. These were termed repo-linked deposit and lending rates.

Though the repo linking didn’t have an immediate effect on SBI’s deposit or loan rates in May, it has resulted in quicker transmission of RBI’s rate cuts to SBI’s depositors and borrowers in the three months since. When SBI announced these changes in March 2019, the repo rate was 6.25 per cent, its savings account rate was 3.5 per cent and it had short-term loan rates of 8.5 per cent. But with the repo rate being cut by 85 basis points since then, SBI’s savings accounts with over a ₹1 lakh balance now earn just 2.65 per cent while it extends overdrafts and cash credits at a floor rate of 7.65 per cent. However, SBI is free to charge a spread over this floor rate to individual borrowers.

Five other banks — Syndicate Bank, Union Bank, Indian Bank, Bank of India and Allahabad Bank — have now announced plans to roll out their own versions of repo-linked rates.

Curbing inflation or stimulating growth by raising or lowering the cost of money is the key objective of monetary policy. But for a few years now, hikes or reductions in the repo rate by India’s Monetary Policy Committee have had only a marginal impact on the economy because of the partial transmission of these cuts by banks.

Given that banks source only about 1 per cent of their funds from RBI’s repo window and the bulk from deposits from the public, they complain that they cannot slash their lending rates unless their deposit rates moderate. Linking savings account interest rates to the repo rate partly solves this problem by ensuring that banks’ cost of funds fall immediately after every repo rate cut, enabling lending rates to be pruned.

Deposit and lending rate revisions by banks have always been shrouded in mystery, with the base rate and MCLR systems involving complicated internal formulae to arrive at a bank’s card rates. Using an external benchmark like the repo rate makes the process more transparent to retail borrowers and depositors. On the flip side, as both savings bank account and loan rates swing with the repo rate, both depositors and borrowers will need to brace for more volatile rates and keep a closer watch on MPC actions. However, Indian banks have currently linked only a part of their deposits and loans to the repo rate. SBI, for instance, applies it only to depositors who have a balance of over ₹1 lakh in their savings accounts, who make up less than 10 per cent of its deposit base. This is bound to lead to partial transmission.

Banks may willingly prune deposit rates when the repo rate falls and raise loan rates when it rises. But we need to see how repo linking works when the opposite happens.

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