RBI slashes repo rate and unleashes other tools to tackle COVID. What does it mean to banks and borrowers?

After dragging its feet over the past two weeks, the RBI stepped up its efforts substantially on Friday, bringing in much-needed relief to banks, corporates and the financial markets. Aside from slashing the policy repo rate by 75 basis points to 4.4 per cent, the RBI also unleashed various tools to ensure ample liquidity and ease the stress for borrowers and banks by providing a three-month moratorium on term loans and working capital facilities.

While the measures are welcome and will help address many of the issues owing to the increasing impact of COVID-19, the RBI’s measures have put the onus on the banking system to up the ante and provide necessary funding and pass on rate benefits to businesses. Given that the banking system is staring at huge losses and stress in the coming months, could the RBI have gone the Fed way and donned the lender’s suit instead? As it stands, the RBI’s measures though substantial, still does not address the pain point of small businesses and stressed sectors such as airlines and telecom.

Rate action

The first in the series of policy measures announced by the RBI was the 75-basis-point reduction in policy repo rate to 4.4 per cent. This is a substantial cut and huge boost to sentiments. While this could lead to sharp cuts in lending rates, the pace and quantum of transmission would vary across banks.

Remember the 135-basis-point reduction in policy repo rate through 2019 resulted in a 60-bps reduction in lending rates (for fresh loans), indicative of the challenges in the transmission.

But more importantly, with the Covid-19 impact on businesses likely to be massive and long-drawn, the risk aversion of banks to lending is also expected to go up significantly. And hence, banks may be selective in their lending. On the borrowers front too, appetite for fresh loans may remain weak and hence, the benefit on lower lending rate on fresh loans may not be that significant at this juncture. However, the sharp cut in repo rate is a strong sentiment booster for the economy, grappling with the Covid-19 crisis.

Aside from the cut in repo rate, the RBI has also widened the policy rate corridor, by reducing reverse repo rate by 90 bps to 4 per cent (as against 75 bps in repo rate). Reverse repo rate is the rate at which banks lend short-term funds to the RBI. The idea to reduce the reverse repo rate at a much sharper quantum than the repo rate is to dis-incentivise banks to park their excess funds with the RBI.

What for banks: The overall credit growth of the banking system currently is at a muted 3 per cent. This reflects the weak demand and growing risk aversion of banks. A sharp cut in lending rates amid weak credit growth could add pressure on banks’ net interest margin. As such, cost increase on account of tacking the Covid-19 crisis, waiving off of various fees and charges on digital transactions and maintaining of minimum balance ,etc., could also hurt margins.

The reduction in reverse repo rate by 90 bps to 4 per cent may dissuade banks to park money under reverse repo (given that banks offer 3.5-4 per cent on savings deposits). However, given that banks would remain wary of lending to stressed sectors and companies, the RBI’s move may not necessarily prompt banks to scale up lending significantly. In March, banks have parked ₹3-lakh crore under reverse repo on daily average basis, which is indicative of the excess liquidity with banks.

What for borrowers: Banks had introduced repo-linked loans from October last year. Borrowers whose loans are linked to repo will see the reduction in repo passed on to them in the coming months (the RBI has mandated that loans are reset at least once in three months). For old borrowers (pre-MCLR regime or pre-repo-linked loans), fall in lending rates would depend on each banks’ action. One-year MCLR has fallen by about 50 bps since January last year.

While some banks may offer attractive deals to good borrowers, it may be important to exercise caution. Retail borrowers should not over-leverage themselves at this point. With the ramifications of Covid-19 on jobs and incomes uncertain, borrowers should only go for loans on need basis.

Liquidity measures

The RBI also announced various liquidity measures.

One, the RBI has announced targeted long-term repo (TLTRO) of ₹1-lakh crore of three-year tenure, at a floating rate linked to the policy repo rate. The RBI has been providing long-term funds under LTROs since February. What is different now is that the rate at which these funds will be provided will not be fixed at the repo rate. It will be a variable rate linked to repo, which means that the rate will vary depending on the demand from banks for these funds. Hence, the cost could be higher than the repo rate of 4.4 per cent.

Two, banks will have to deploy these funds in investment grade (BBB rated and above) corporate bonds, commercial paper, and non-convertible debentures over and above the outstanding level of their investments in these bonds as on March 27, 2020. Hence, banks do not have the leeway to deploy these funds for other purposes (like stocking up on government bonds).

Three, such investments will be classified as held to maturity (HTM). This means that banks need not mark-to-market these investments at the end of every quarter. This is welcome, as banks would otherwise have been wary to invest in these bonds, fearing treasury losses on account of rising yields (owing to increase in risk perception).

The RBI has also reduced the cash reserve ratio ― amount of cash banks need to keep with the RBI — to 3 per cent from 4 per cent. It has also allowed banks to dip into their SLR (portion of deposits held in government securities) to the extent of 3 per cent (from 2 per cent) under the marginal standing facility (MSF). This means that banks can borrow an additional ₹1.37-lakh crore at the MSF rate of 4.65 per cent.

What for banks: The measures to infuse additional liquidity into the banking system will help banks ease their funding needs. However, to what extent banks use the additional liquidity will depend on each banks’ needs and appetite for lending. For instance, in case of TLTRO, while the HTM leeway will induce banks to invest in specific corporate bonds, the extent of borrowing will depend on each bank. As such, the demand for LTROs has been waning (read my story on https://www.thehindubusinessline.com/portfolio/news-analysis/why-rbis-latest-ltro-auction-saw-weak-response/article31106587.ece ), implying limited options with banks to deploy the funds. However, PSU banks may be nudged by the Centre to buy corporate bonds. Similarly, the additional liquidity under CRR and MSF will also be utilised selectively by banks.

What for borrowers: For the high-rated corporates, the TLTRO move is a big positive, as it will ease up funding issues to an extent. However, for the more vulnerable segments and sector (BBB and below rated companies), the pain could continue as banks would be wary of lending to them. Sectors such as aviation, can continue to find it difficult to raise funds.

Moratorium relief

As was widely expected, the RBI has provided three-month moratorium on payment of instalments on terms loans (outstanding as on March 1). It has also allowed deferment of interest of three months on working capital facilities. It has allowed lenders to re-assess the working capital needs of corporates and extend credit facilities if need be.

Changes in terms and conditions of the term loans or working capital facilities will not result in asset classification downgrade. These will be available to all commercial banks, co-operative banks, financial institutions, and NBFCs (including housing finance companies and micro-finance institutions).

What for banks: This is a huge respite for banks, as the Covid-19 impact is expected to be widespread leading to rise in defaults and hence, NPAs. The blanket forbearance for all term loans and working capital facilities, will help all lenders to cap their losses and erosion in capital. However, given that the Covid-19 impact is expected to extend beyond three months, banks could face increased stress after the moratorium is lifted. Hence, fiscal measures by the Centre to ease the pain will be critical. Also, the accumulated deferred interest payment for working capital will have to be paid after three months. If the pain for corporates does not ease, then paying the accumulated interest will be a tough task, leading to stress for banks.

What for borrowers: All borrowers with term loans, including retail borrowers with home loans and personal, will likely get the benefit of the moratorium. Hence, your EMIs on these loans may get a three-month respite. While more clarity is awaited from bankers on this, it appears that credit cards will not be covered under the moratorium. Clarity is also awaited on the procedural aspects, as borrowers usually give an ECS mandate on EMI payment. Banks could auto-provide the moratorium (else getting approval from each borrower on the changed terms and conditions would be difficult).

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