Rate Watch. What RBI’s policy holds for borrowers, depositors

By holding the repo rate for the second consecutive time since its cut in last October, the RBI has not sprung any surprise. With inflation on the rise, the central bank had little leeway to reduce its policy rate.

That said, the central bank has, through a series of liquidity and regulatory tweaks , opened up the possibility of fall in lending rates in certain segments such as auto, home and MSME loans.

Also, by implementing the long-term repo of one- and three-year tenors, the RBI will make long-term funding available to banks at much cheaper rates. This will lower cost of funds and trigger further lending rate cuts.

Better transmission

The RBI had lowered its policy repo rate — the rate at which banks borrow short-term funds from the RBI — by 135 bps in 2019. But the weighted average lending rates on new loans (until December) have fallen by 70 bps on an average across banks. For old borrowers (pre-MCLR regime or pre-repo-linked loans), lending rates appear to have hardly changed. Since last January, the weighted average lending rates on outstanding loans have fallen by just 13 bps.

To improve transmission, the RBI mandated banks to link their loan rates to the external benchmark (most banks have adopted repo rate) from October 1. This was to ensure that every time the RBI cuts its repo rate, lending rates also move down. But the transmission continues to be weak.

This has been due to multiple reasons.

One key reason has been that, until October, when banks had introduced repo-linked loans, the RBI had already cut its repo rate by 110 bps. As a result, borrowers had lost out on a chunk of the rate cut.

Two, under the external benchmark structure, the RBI mandated that loans are reset at least once in three months, provided there are changes in the underlying benchmark repo rate. Hence, banks have not been in a hurry to reset their lending rates. For instance, SBI introduced anexternal benchmark rate (EBR) in October, which is repo rate plus 2.65 per cent.

Despite the repo rate falling to 5.15 per cent after the cut on October 4, 2019 (from 5.4 per cent earlier), SBI continued to benchmark its loans against the EBR of 8.05 per cent (repo rate of 5.4 per cent plus 2.65 per cent) until December. It was only from January this year that the SBI lowered its EBR to reflect the repo rate cut in October.

SBI’s home loans are now benchmarked against EBR of 7.8 per cent (5.15 per cent plus 2.65 per cent). Hence, while the transmission under repo-linked structure is faster than under the MCLR regime, it is still not instant.

That said, given that many banks have revised their external benchmark to reflect the existing repo rate of 5.15 per cent, transmission has improved in the past month. Between January andNovember 2019, average lending rates on fresh loans had fallen by 50 bps. As of December, the decline in lending rates was a sharper 70 bps (from January).

While better transmission is good news for borrowers, hopes of the RBI holding rates for a long while, will limit sharp cuts in lending rates here-on.

No sharp cuts, but relief in pockets

But the RBI incentivising credit to certain segments such as automobiles, residential housing and MSMEs, in the form of relaxation on CRR (to the extent of incremental loans), can lead to significant fall in lending rates in some of these segments in many banks. Conducting long-term repos will also aid in lowering banks’ cost of funds and, in turn, lending rates.

Until now, only new floating rate retail loans and loans to micro and small enterprises (MSEs) extended by banks were linked to external benchmarks. The RBI has, from April 1, mandated to link loans to medium enterprises also to external benchmarks. This should bring down lending rates in such loans too.

What borrowers should do

If you have been waiting on the sidelines, hold on for some more time to see how far lending rates on loans such as home loans and auto loans fall in the coming weeks. Many leading banks may lower lending rates significantly in certain loans. If you are looking to make big-ticket purchases such as home, watch out for the best deals offered by banks. Also, many banks have set varied rates based on the borrower’s risk profile and credit score. If you have been a disciplined borrower and have a high credit score, you could get a far more attractive deal. For instance, in the case of Central Bank of India, a spread of 0.3 per cent over the repo-linked interest rate is applicable if you carry a low risk; else, a spread of 0.4 per cent is charged.

While choosing a loan, consider the spread charged to you by each bank. Go with banks that charge a risk premium based on transparent credit bureau scores rather than opaque internal policies.

Based on information on banks’ websites, as on February 6, for a salaried borrower (male) looking for home loans in the ₹30-75-lakh bucket, Bank of Baroda, Bank of India, Central Bank of India, SBI and Union Bank offer among the cheapest rates in the market. The best effective lending rates on these home loans range between 8 and 8.2 per cent.

Banks lowering lending rates in some segments, will only benefit new borrowers (banks may lower spreads over repo linked benchmarks). Hence, if you are an existing borrower, switching to cheaper loans may appear alluring. But make the switch only if the benefit is substantial (on interest savings). Also, given that the RBI’s future rate cuts will be limited hereon, remember that when the central bank starts to hike rates in the long run, repo-linked loans can pinch you. Hence, if you have taken loan under the earlier structure, don’t be in a hurry to make the switch to repo linked loans if your loan tenure is coming to an end.

Depositors’ woes

While borrowers may see some benefit post the RBI policy, depositors may be in for a rough ride.

As such, sharp cuts in deposit rates have pinched depositors in the past year. Since January, fixed deposit rates in certain banks and tenure have moved lowered by as much as 75-100 bps. Adding to the pain, SBI had trimmed the interest rate on its savings deposits (of up to ₹1 lakh) to 3.25 per cent from 3.5 per cent, effective November.

While the RBI did not cut repo rate this time around, the other regulatory tweaks (mentioned above) can result in lower deposit rates. Freeing up banks’ funds (some CRR relaxation) and providing long-term money at much lower rates (term repos) give banks enough leeway to lower deposit rates significantly.

So, how can you cushion yourself from the pain?

If you have ample surplus funds, don’t let them lie in your savings account, as most banks offer meagre rates on savings deposits. If you have a very short-term horizon, moving to less-than-one-year FDs can straightaway earn you a higher 6-6.5 per cent.

If you have a long-time horizon, stick to a one- to two- year option at this juncture, as it can allow you to cash in on rate hikes that may kick in after a year. Look for attractive fixed deposit rates across banks, including small finance banks that offer higher rates than traditional banks.

The Budget has set the ground for a higher deposit insurance cover of ₹5 lakh from ₹1 lakh earlier. This means that you can park more sums in a bank than before, and earn higher returns on your fixed deposit investments without losing the full cover. This can help maximise your returns.