Cheaper credit only after deposit rate cut

Announcing a 25-basis point cut in the repo rate on Tuesday, Reserve Bank of India (RBI) Governor Urjit Patel voiced displeasure at banks not doing enough to pass on the benefit. The banking regulator expects banks to make loans cheaper over the coming quarters.

Bankers say the plans are in line with RBI's expectations but with a twist. The central bank would bite the bullet (that is, reduce rates further on loans) after slashing interest rates on deposits.

Banks have been reviewing rates each month under the marginal cost of funds-based lending rates (MCLR) regime since April. Much of the revision has been downward, though the quantum of reduction has been only 5-10 basis points (bps). The MCLR regime was designed taking into account limitations of both the benchmark prime lending rate (BPLR) and the base rate regimes.

WHY BANKS DON’T CUT RATES

• Fixed interest rates on savings deposits stifle transmission
   
• No or small reduction in small savings rates
   
• Piling stress loans and pricing of risk premium
   
• Sluggish demand for bank loans Source - RBI monetary report

B Sriram, managing director, State Bank of India, said those benefitting from the Seventh Pay Commission will place money with banks. The government has also cut the small savings deposit rates by 10 bps. This would give room to reduce deposit rates and cost of funds, and further the revision in lending rates would follow.

Sriram said banks would need six more months to adjust to the MCLR system, which would complete one year in March 2017. After this there would be scope for more transmission.

Ravindra P Marathe, chief executive officer and managing director, Bank of Maharashtra, said monetary policy transmission was already structured into the MCLR methodology and was largely dependent upon the cost of deposits.

The rate cut is indicative of the softening of the interest rate regime in the economy. This was expected to pump-prime the fresh investment cycle. Interest rates were bound to come down, bankers said.

The RBI governor, in his remarks at the press meet after the policy said, there were two parts to transmission. One, the transmission through the money markets had been swift and decisive and corporates were using those parts of the financial system more compared to plain-vanilla bank credit.

The transmission to bank lending and to bank borrowers had been less than what the regulator would have wanted, the governor said.

The MCLR calculation itself would now throw up more transmission, Patel said, adding that for new lending, the transmission had been much more in terms of the rates coming down.

During the first half of 2016-17, the median one-year MCLR of public sector banks and private banks declined by 15 bps and 25 bps, respectively.

Banks have, however, increased the spread and term premia over the same period, effectively leaving the weighted average lending rate (WALR) on outstanding rupee loans unchanged. For fresh rupee loans, the WALR declined by 5 bps (April-August 2016). Rupee loans that are being disbursed since April 1, 2016, are priced at the MCLR, and therefore, the base rate continues to account for a substantial share in the pricing of outstanding credit.

The transmission of monetary policy is marked by long and variable time lags with asymmetric market responses to policy impulses - generally higher during a tightening phase and lower during an easing phase, irrespective of the prevailing regime for pricing of credit.