Reserve Bank nudges banks again to transmit rate cuts faster

The Reserve Bank of India (RBI) has again prodded banks to reduce lending rates at a faster pace. Though the central bank has reduced the repo rate by 150 basis points (bps) since January 2015, lenders have managed to lower their rates by only 70-80 bps.

Adopting a caustic tone on lenders' reluctance to cut rates, Governor Raghuram Rajan said banks have been coming up with new reasons every time to hold on to current rates.

“Despite easy liquidity, banks have passed past rate cuts into lending rates only modestly. Earlier, some bankers said it was the lack of liquidity that was holding rates high, now I hear from some that it is fear of the FCNR (B) redemptions that is making them reluctant to cut rates... I have a suspicion that some new concern will crop up once the FCNR (B) redemptions are behind us,” Rajan said.

FCNR (B) stands for foreign currency non-resident (bank) accounts, which can be opened with an Indian bank by a non-resident Indian or a person of Indian origin in foreign currency.

To improve transmission, the regulator had asked lenders to move to a marginal cost of funds-based lending rate (MCLR), which came into effect on April 1. This new benchmark for pricing of loans is based on marginal cost of funds instead of the average cost of funds. This should have enabled banks to pass on the rate cuts quickly.

However, despite adopting this new regime, the transmission has improved further by only 20-30 bps. As a result, RBI is reviewing the MCLR framework after taking suggestions from bankers and will be soon suggesting some changes.

Rajan said once banks’ balance sheet was cleaned and the economy recovered, this was when we were likely to see increased transmission. “Substantial pass-through will happen only as corporate credit demand picks up, and public sector banks, strengthened by clean balance sheets, compete for corporate business.”

Bankers seemed to echo the RBI governor’s sentiment. “We believe transmission of rates will happen gradually over the next few months as credit growth picks up pace,” said Arundhati Bhattacharya, chairman, State Bank of India.

As overall credit demand continued to hover in single digits and especially since corporate demand has been muted, banks do not see a strong case for reducing lending rates.

Earlier, the government had also questioned banks about their unwillingness to cut rates. The banks, in their defence, had said apart from low credit demand, the ballooning pressure of bad loans and the incremental pressure on margins had also deterred them.