The policy rate conundrum

V Viswanathan | Updated on December 02, 2020 Published on December 02, 2020

For both borrowers and depositors, the repo rate cuts haven’t quite paid off

The banking industry has been witnessing a churn over the past few years. If different players in the sector were to meet up for a discussion, perhaps it will run something like this:

Regulator to banker: Since 2019, we have reduced policy rates by 250 basis points. Have the benefits been passed on to the customers?

Banker: Yes sir. We have reduced our deposit rates. On fixed deposits, from 8-9 per cent in 2019 to 5-6 per cent now. Since the repo rate is a daily rate impacting our call money and treasury bills rates, interest on demand deposit like savings has also been reduced by 100-125 bps.

Thanks to the transmission, we could improve both our net interest margin and net interest income. This comes in handy to improve our operating profit, as the income stream has been on the decline during Covid.

Regulator to government official: Sir, did this help you in your borrowing programme?

Government official: Not to the extent of the policy rate reductions. The 10-year G-Sec, which was ruling at around 7.40 per cent, is now at 5.80 per cent. Reduction in interest outgo on borrowings helps the government, as the decline in tax and non-tax revenues is quite steep. Even with reduced interest rates, banks are willing to subscribe, since their cost of funds is less than 5 per cent.

The rate is quite attractive as they will get only 3.35 per cent if they choose to invest the surplus in reverse repo. We are tempted to borrow more at the prevailing rates.

Regulator to bank borrower: Hope you have got the best interest rates now.

Bank borrower (new and existing): The bank said it reduced the repo rate-linked lending rates (RPPL) for new loans last year. After six months, I approached them for a new loan. While the old loan rate, which was charged at 2.25 per cent over the repo rate, got reduced along with the repo reduction of 25 bps, the new loan had no reduction. For the new loans, the bank said RPPL is charged at 2.5 per cent over the repo rate.

I also enjoyed loans linked to the MCLR (marginal cost of funds based lending rate) and I found that my loan is carrying the same rate of interest, though the bank reduced its MCLR, in between, by 100 bps. Incidentally, I noticed that the reduction in MCLR was not in line with the amount of reduction in the repo rate. When I enquired, I was told that as per agreement, the contracted rate applies and if I want to get the new rate, I should give a letter and pay a fee. The formula for MCLR and RPPL are different and MCLR should not be compared with the reduction in repo. If I wish to move over to RPPL, I need to give a letter and an accompanying fee again.

In some of the loan rates, the reduction was not much. The bank explained that one should look at factors like tenor of the loan, credit risk perceived from the bank’s point of view, credit ratings, CIBIL score, etc., when the loan rates are compared with repo rate reduction.

On the whole, I am really confused as to whether I got the benefit of a reduced interest rate or not.

Regulator to bank borrower: We appreciate your concerns. Since the beginning of this millennium, we are engaged in this issue of transmission of policy rates. We prescribed prime lending rates (PLRs) to the bankers. Then we implemented benchmark prime lending rates (BPLRs). Since the interest rates became too low, we moved over to Base Rate with cost of funds as the anchor to arrive at the Base Rate.

We were not happy with the results and implemented MCLR. Finally, we moved over to external benchmark linked rates to solve the issue. We understand from our talks with you that there are still some issuest. We will appoint an expert committee to come out with recommendations as to whether internal and external benchmarks can be combined to arrive at lending rates for bank borrowers. Hope you understand the situation.

Bank borrower: We understand your problems and also that our difficulties will not end soon. Thank you, sir.

Senior citizen depositor to regulator: I have a small issue. I am not a pensioner. I depend only on interest income. I do not enjoy standard deduction benefit on taxable income. I am over 70 years old and do not qualify for life or health insurance. The drop in interest rates is deep. Earlier, banks were offering interest rates 50 bps higher than the normal deposit rates for senior citizens. Now that is also reduced. Every one says repo rate reduction is the cause for the reduced deposit rates, though we do not know what is the meaning of repo. Can you increase the repo rate next time so that we will get higher interest rates on our deposits.

Regulator: We do not have any guarantee that any reduction in repo rate will result in interest rate reduction for loan customers. In the same way, we are not sure whether any increase in the repo rate will translate into higher interest rates for depositors. We have to think now as to what should be announced after ‘on-tap TLTRO’ — to maintain liquidity in the financial system for the benefit of the three (government, bankers, borrowers). We will certainly listen to you patiently, once normalcy is restored. Till such time, kindly bear with us. Stay safe and please follow Covid guidelines issued by the government.

As the government official and the banker were waiting for the senior citizen to come out, to resume their discussions with the regulator in his chamber, I leave the scene quietly.

The writer is a former CGM, e-State Bank of Hyderabad

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Published on December 02, 2020
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