Meaningful transmission may not happen as banks’ margins are already under pressure
After a long pause and much clamour, the RBI finally cut its policy repo rate by 25 basis points to 6 per cent. But the much-awaited move may not bring much respite to borrowers. At best, lending rates that have remained more or less unchanged after the steep cuts in the beginning of the year, could move lower by a token 10-15 basis points.
Depositors, however, may continue to see rates fall (though modestly) on their fixed deposits. With the SBI trimming rates on savings deposits, many others could follow suit, pinching depositors.
Spate of cuts
The RBI’s rate easing cycle that began in January 2015, saw a 125 bps fall in repo rate in 2015 and another 50 bps in 2016. But banks, as in the past, had been tardy in passing on these cuts until the beginning of this year.
Ideally, when the repo rate — the rate at which banks borrow short-term funds from the RBI — is cut, it should result in lower cost of borrowings for banks and hence, translate into lower lending rates for borrowers.
But there are two main reasons why this doesn’t happen in practice. One, though the repo rate is the policy rate, banks actually source only a minuscule portion of their funds (1 per cent) from the repo window.
With banks relying significantly on longer-term deposits, only about 50-60 per cent of banks’ funding gets re-priced. Hence, a cut in repo rate does not immediately reduce their costs.
Two, the liquidity situation is a key determinant of the pace of transmission. Ideally, for rates to come down meaningfully, there has to be ample liquidity in the system.
Banks moved to the Marginal Cost of Funds-based Lending Rate (MCLR) system last April, which considers the latest (at the time of review) rates offered on deposits or borrowings. While this has helped somewhat in better transmission, the sharp cut in lending rates since the beginning of the year was essentially due to the surplus liquidity in the system post demonetisation.
Up until the SBI slashed its MCLR by 90 bps in January, leading banks had lowered their benchmark lending rates by just 25-30 basis points, despite more than a percentage fall in deposit rates in 2016. Following the SBI’s move, other banks were quick to follow with a 70-80 bps cuts.
But since then, banks have kept the MCLR more or less unchanged.
The benefits in the form of surplus inflows post demonetisation have been waning. While banks have continued to trim rates on fixed deposits in recent months, it has not translated into lending rate cuts.
Going ahead, rates on fixed deposits may continue to fall, but the quantum and pace will vary across banks. It is unlikely, however, for rates to fall very sharply from hereon, as banks will require longer-tenure deposits. Thus, the scope for a meaningful fall in lending rates is unlikely.
Two, the bulk deposits on which banks use their discretion to set rates, earned lower interest rates than retail deposits post demonetisation.
With liquidity gradually draining out, rates on such deposits have been inching up. Given that the MCLR uses the latest rates on deposits for computation, this is bound to exert upward pressure on the MCLR.
Instead of raising the MCLR, which would have been bizarre, the SBI trimmed its rates on savings deposits early this week. Many others are likely to follow suit.
While the RBI’s 25 bps cut in repo rate opens up some headroom for deposit and hence, lending rates to move lower, big moves are unlikely.
While banks will immediately reap the benefit of cuts in savings deposit rates (on fixed deposits the benefits accrue with a lag only when they come up for renewal), they are unlikely to pass them on to borrowers by lowering the MCLR. Rather, they are likely to use such cuts to cushion margins.
Banks are already facing margin pressure on account of sharp cuts in the MCLR and the recent increase in incremental cost of funds. Unless the SBI and other leading banks wield the scissors, lending rates will only come down in fits and starts.
While deposit rates fell by a substantial 50-100 bps across banks between November and February, it has continued to fall by as much as 50-75 basis points in a few public sector banks in recent months.
Given that banks will have to keep outflows on longer deposits under check, aggressive cuts in fixed deposit rates may not happen. But depositors may have to brace themselves for more cuts in savings deposit rates by other banks.