*Bond Market: Banks, bond market stay ahead of RBI – The Economic Times

Clipped from: https://economictimes.indiatimes.com/opinion/et-editorial/banks-bond-market-stay-ahead-of-rbi/articleshow/90942964.cms


In essence, banks and the bond market are now ahead of the RBI on the interest rate upcycle.

A clutch of banks, including the country’s overwhelmingly biggest lender, the State Bank of India (SBI), have begun increasing lending rates that are indexed to the cost of money raised from depositors and from the market. Over half of bank lending in India is based on the marginal cost of funds-based lending rate (MCLR). With banks hiking this rate for the first time since the Covid pandemic, interest rates have begun climbing in advance of the Reserve Bank of India (RBI) changing its accommodative monetary policy stance. Bond markets had already moved in anticipation. Gilt yields have spiked since the central bank prioritised inflation over growth in its monetary policy review earlier this month.

Banks are increasing the MCLR to protect their margins, as deposit rates have risen while lending rates remained flat. Their retail lending grew three times as fast as corporate lending between 2011 and 2021. A moratorium on loan repayments by individuals and a squeeze on borrowing by companies over successive waves of lockdown tipped bank lending further into the retail segment. The RBI requires banks to index lending rates for individuals to external benchmarks like the policy repo rate, which has not changed since the pandemic, and gilt yields, which have hardened in recent months. Most of the corporate loan book is, however, pegged on the MCLR, over which banks have greater control.

In essence, banks and the bond market are now ahead of the RBI on the interest rate upcycle. On its part, the RBI was drawing down excess liquidity through variable rate reverse repo auctions where the cut-offs were just shy of the 4% repo rate. It has also raised the rate at which banks can park excess cash with it through the standing deposit facility. In the process, it has narrowed the policy band around the repo rate to 50 basis points. The central bank has been nudging the banking system to base lending rates on the policy rate, and has found evidence of improved monetary transmission.

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