News Analysis

Banks’ lending, deposit rates to move higher

Radhika Merwin BL Research Bureau | Updated on August 01, 2018

Taking cues from the bond market, banks have been raising deposit and lending rates since January this year.

While the RBI has retained its neutral stance, risks to inflation leaves open the possibility of further rate hikes in the current fiscal

Banks that have been raising lending rates over the past six months—RBI’s rate action or no—have been handed yet another reason to continue hiking rates. The RBI’s latest move to increase its key policy repo rate—at which banks borrow short term funds from the RBI—by 25 basis points, will nudge banks to pass on rate increases to borrowers and depositors. While the RBI has retained its neutral stance, upside risks to the central bank’s inflation forecast persists. As against the RBI’s inflation projection of 4.8 per cent in the second half of FY19, we believe that CPI inflation could move to 5.2-5.4 per cent.

This leaves open the possibility of further rate hikes in the current fiscal, indicating further hardening of rates. Hence banks, taking cues from the bond market, will likely continue to hike lending rates ahead of the curve.

Already on the rise

Interestingly, it was in August last year, that the RBI had last cut its policy repo rate. But concerns over rising inflation and tightening of global liquidity had, uncannily, led to a sharp upmove in the yield on 10-year government bonds. Taking cues from the bond market, banks have been raising deposit and lending rates since January this year.

While deposit rates have gone up by 25-35 basis points on an average, a few banks have raised interest rates on specific tenure deposits by 60-75 bps.

Since deposit rate increases immediately reflect on banks’ cost of funds under MCLR, hikes in lending rates have also been much quicker and sharper, than under the erstwhile base rate system. As such, banks have always been more nimble in passing on rate hikes to borrowers.

Banks’ benchmark lending rate—one-year MCLR—has gone up by 20-25 bps on an average, to as high as 70 bps in a few banks over the past six months.

But despite such sharp increase, bank lending rates are still lower than what corporates would have to cough up, while raising money from the bond markets. Yield on AAA rated and AA rated bonds currently quote at 8.4-8.5 per cent and 8.8-9 per cent respectively. For many banks, in particular PSU banks, one-year MCLR is still below the 8.5 per cent mark. Hence, banks in any case had some leeway to increase lending rates. The RBI’s recent hike, has only offered more headroom for banks to raise lending rates. Hence borrowers are likely to feel the pinch in the coming months.

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.

What for banks

Going by recent quarter results, increase in deposits rates that in turn bump up banks’ cost of funds have added some pressure on banks’ margins—YES Bank, IndusInd Bank and HDFC Bank to name a few. This could ease up, as the benefit of the hike in lending rates starts to reflect in banks’ yield on advances, in the coming quarters. However, this is contingent on credit offtake and asset quality performance to a lot extent.

While credit growth has inched up notably in FY18 growing by about 10.3 per cent YoY, it is still below expectations and lags the overall growth in the economy. For banks with relatively higher exposure to stressed assets, the NPA recognition cycle is yet to bottom out. Sharp slippages and provisioning will continue to weigh on earnings. The rise in lending rates could only accentuate the bad loan issue. The first cut of India Inc. June earnings suggests a near 29 per cent YoY increase in interest cost for about 310 entities.

Published on August 01, 2018

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