Rate reversal

The decision by the country’s largest bank, SBI, and other lenders such as ICICI Bank, Axis Bank and PNB to hike their lending rate across tenors by 10-25 basis points with effect from March, has come in for widespread criticism. Critics see this as yet another attempt by these banks to extract an additional pound of flesh from their customers as their profits take a renewed battering from loan-loss provisions and newly unearthed frauds. While banks have been guilty in the recent past of padding up their profits through unreasonable charges, the present move to hike lending rates appears to be a legitimate commercial decision, driven by tightening debt market conditions and the rising cost of bank funds.

When the RBI ushered in the Marginal Cost of Funds Based Lending Rate (MCLR) in place of the base rate regime in April 2016, its intent was to ensure quicker transmission of policy and market rate changes to borrowers, by requiring banks to peg their lending rates to their incremental cost of deposits, rather than the sticky average cost. The new dispensation did see banks effect faster cuts to their MCLRs over 2016-17, especially after demonetisation flooded them with liquidity that forced down deposit rates. But from the middle of 2017, deposit flows have thinned out, credit offtake has picked up, and there has been a sharp spike in the banks’ incremental credit-deposit ratios. Banks have thus had to peg up their bulk deposit rates by 50-100 basis points in the last three months, with retail deposits now following suit. Higher deposit rates apart, banks are also facing upward pressure on their cost of funds from rising market rates. Factors such as the fiscal deficit overshoot, tighter liquidity and rising global rates have seen the yield on the benchmark 10-year gilt shoot up by over 130 basis points in the last six months. With the cost of sovereign borrowings at 7.74 per cent, it is unrealistic to expect banks to stay with a sub-8 per cent MCLR for other borrowers.

With market yields shooting up and banks hiking lending rates, the Monetary Policy Committee should now worry about falling behind the curve in responding to fast-changing debt market conditions, in setting its policy rates. For domestic borrowers, the honeymoon period on borrowing rates seems to be well and truly over. Of course, it is another matter that for them, even the MCLR regime proved far from perfect. While newer borrowers from April 1 2016 have been on the MCLR, older ones continued to be subject to steep base rates that banks had pegged 80-90 basis points higher. The RBI recently proposed, but has not fleshed out, new rules requiring banks to link their base rates to the MCLR. But with the rate cycle reversing, this intervention may now come a tad too late to rescue the hapless retail borrower.

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