Following a meeting of its Monetary Policy Committee on August 7, the Reserve Bank of India (RBI) once again cut its repo rate-the rate at which it lends to commercial banks-by an unexpected 35 basis points (0.35 per cent), rather than the customary 25 basis points (0.25 per cent).

It was the central bank's fourth rate cut in a row since former bureaucrat Shaktikanta Das became its governor. However, a key question remains-how quickly will commercial banks cut their own lending rates and pass on the benefit of the RBI's cut to customers (known as 'transmission' in banking parlance), be they individuals or corporates?

In its June 2019 monetary policy review, the RBI had cut the repo rate by 25 basis points (0.25 per cent). Following the latest rate cut, the cumulative back-to-back reduction in the repo rate this year has been to the tune of 110 basis points (1.1 per cent), with the rate currently at 5.4 per cent. However, the full benefit of these reductions has not been passed on to customers. For instance, at the June policy announcement, Das said that banks had passed on only 21 basis points (0.21 per cent) of the cumulative 50 basis point (0.5 per cent) rate cuts in February and April this year. Reports suggest that as on July 6, banks had lowered their benchmark lending rates, called MCLR, or marginal cost of funds-based lending rate, by just 10-20 basis points (0.1-0.2 per cent). However, on August 7, the country's largest lender, State Bank of India (SBI), lowered its MCLR by 15 basis points (from 8.4 per cent to 8.25 per cent), following the RBI's latest repo cut. (The MCLR is the minimum interest rate a bank can charge.)

Moreover, in January 2019, the weighted average lending rate of banks' outstanding loans was 10.38 per cent, but in May, had moved up to 10.41 per cent. Thus, despite the RBI's repo rate cuts, the interest rate on banks' outstanding loans has climbed, rather than falling. Reports say that issues related to slow transmission rates came up in the 20th meeting of the Financial Stability and Development Council, chaired by finance minister Nirmala Sitharaman, on June 19. Following this, the Department of Financial Services, under the Ministry of Finance, is said to have started collating data on interest rate cuts by state-owned banks. This may not cut much ice with commercial banks.

Why do commercial banks take so long to pass on the rate cuts to their retail customers? Ideally, when the RBI cuts repo rates, banks should reduce their MCLRs, leading to a reduction in interest rates on loans to customers. Key to understanding this is the way the rate is calculated. Banks calculate their MCLRs based on the cost of raising new funds, which includes the cost of maintaining the mandatory cash reserve ratio (CRR, the proportion of total deposits that banks have to maintain with the RBI) and statutory liquidity ratio (SLR, the proportion of total deposits that banks need to maintain themselves as liquid reserves), as well as their operating costs, etc. "The problem with the MCLR is that it is driven by a formula," says Madan Sabnavis, chief economist with Care Ratings. "The formula includes the cost of deposits, which depend on deposit rates, provisions for non performing assets, returns on capital, etc." Banks have claimed that their cost of funds have remained high due to high deposit rates. "If the deposit rate does not change significantly, a bank's lending rate also will not change much." On this count, SBI recently revised its deposit rate downward-a deposit below Rs 2 crore for three to five years will earn a rate of 6.6 per cent from August 1, compared to 6.7 per cent earlier. Another factor is that deposits have fixed rates till maturity. Therefore, even if deposit rates are lowered, the cost benefit to a bank would come with a lag, says Sabnavis. However, lending rates are flexible-if a bank changes its rates today, all loans will have to be priced at the new rates, benefiting customers but not the bank.

On August 7, Das said that the country's biggest lender, SBI, has taken steps to improve its transmission of the RBI's rate cuts, such as linking large savings account rates and some loan products to the repo rate. It said that even as past rate cuts are gradually being transmitted to the real economy, the benign inflation outlook provides headroom for policy action to close the negative output gap. "If banks are able to pass on this reduction in the prime lending rate to consumers, budget housing demand may also improve further," says Niranjan Hiranandani, MD of the Hiranandani group. "The rate cut aims to encourage consumer spending in [this] rather gloomy scenario, given the economic slowdown and declining consumption."

Despite RBI's unexpected rate cut of 35 basis points, Indian stock markets slid as the central bank revised the GDP growth forecast for the current fiscal to 6.9 per cent from 7 per cent earlier. However, the markets revived following media reports that the Centre might announce a roll-back on tax on foreign portfolio investors. The Bombay Stock Exchange Sensex gained 254.55 points to close at 37,581 points on August 12.

Will the repo rate cut help improve private investment, which has been lagging so far? Apart from the rate cut, the RBI has announced a continuance of its accommodative stance and specified norms for how much of a bank's paid-up capital can be lent to a single non-banking financial company (NBFC). The issue, as discussed above, has little to do with interest rates and more with the banking system itself, where a combination of a huge pile of bad loans and a cloud of mistrust hangs over lending decisions. The confidence to lend for infrastructure projects need to be brought back to the market. "The focus has to be more on transmission of the rate cuts to the lending rates, as a 75 basis point cut in the repo rate has only translated to a 29 basis point reduction in the lending rate on fresh rupee loans during Febuary to June 2019," says Arun Singh, chief economist, Dun & Bradstreet India. "Continued weak credit growth to the micro and small sector and negative export credit growth for more than two years will require special interventions, which the government is trying to address." Jyoti Vaswani, chief investment officer, Future Generali Life Insurance, said that the rate cut "would aid in addressing incumbent growth concerns by way of boosting aggregate demand and private investmentThe focus of the central bank on spurring growth and addressing the NBFC issue will provide much needed respite to markets." Industry players stressed the need to speed up transmission of the lower rates to end consumers. "The RBI's rate cut of 35 basis points has given a much-needed breather to the liquidity and consumption volatility [issues] in the Indian economy. This move will definitely help to ease the burden on current as well as prospective home buyers, provided that banks reciprocate and lower their respective MCLRs, which directly impacts the interest rate cut of home loans," says Amit Ruparel, MD, Ruparel Realty.

Published On : 13-08-2019

Source : India Today