Borrowers from formal banking channel can now heave a sigh of big relief with the latest decision of the Reserve Bank of India (RBI) to link floating rate loans in the personal, retail, micro, small and medium enterprise (MSME) categories to external benchmarks, including the repo rate with effect from October 1. Repo rate refers to the rate at which commercial banks borrow money from the RBI. This has been necessitated because whenever the apex bank cuts policy lending rate which is called repo rate, the banks were unwilling to cut their lending rates commensurately.
The move is designed to ensure faster transmission of monetary policy rates as trade, industry and consumers all have been concerned that the banks have been reluctant to cut interest rates they charge on borrowers even when the RBI cut the policy rates by a few notches. Thus when the RBI lowered the repo rate by 75 basis points (bps) between February and June this year in its periodic bi-monthly policy rate decisions, the weighted average lending rate on fresh rupee loans at banks were lowered only by 29 bps.
For quite some time and in the wake of the slowdown of the economy and low offtake of credit from the stakeholders in the real sectors, the RBI has been looking at various ways in which banks could be made to transmit repo rate cuts to depositors and borrowers. One major initiative that banks have come up with is repo-linked deposit and lending rates. Beginning from May this year, the country’s largest bank State Bank of India (SBI) announced that it was linking the interest rate on its savings bank accounts as well as short-term loans to RBI repo rates. Five other banks—Syndicate Bank, Union Bank, Indian Bank, Bank of India and Allahabad Bank—have announced plans to roll out their own versions of repo-linked rates.
Given that banks source only about a microscopic one per cent of their funds from RBI’s repo window and the bulk from deposits from the public, they bemoaned their inability to slash lending rates unless their deposit rates moderate. Hence linking savings account interest rates to the repo rate partly solves this problem by ensuring that banks’ cost of funds fall immediately after every repo rate cut, enabling the lending rates to be lowered.
The three external benchmarks the RBI has proposed for linkage of new home and auto loans are its policy repo rate, the Government of India’s three-month and six-month treasury bill yields published by Financial Benchmarks India Private (FBIL), or any other benchmark market interest rate published by FBIL. RBI has also allowed banks to offer such external benchmark linked loans to other types of borrowers as well, apart from retail floating home and auto loans and MSME loans. However, banks have to follow a uniform external benchmark within a particular loan category.
Mysterious are the ways in which deposit and lending rate revisions of banks take place hitherto, with the base rate and marginal cost-based lending system (MCLR) systems entailing convoluted internal formulae to arrive at a bank’s card rates. It is an open secret that the inadequate transmission of policy rate moves has kept the apex bank worried for quite some time. It is in this context that using an external benchmark like the repo rate renders the process transparent to retail borrowers and depositors.
Migration to the new loan pricing methodology will aid faster monetary transmission but will bring in more volatility to spreads/margins for banks across cycles. No doubt banks may be more than willing to prune deposit rates when the repo rate falls and raise loan rates when it rises. While the latest move is bound to lower the interest cost on new floating rate loans availed by borrowers to purchase vehicle or homes, it might also compel the commercial banks to start cutting the interest rate they pay depositors or risk seeing their margins shrink, policy analysts say.
Script: G.Srinivasan, Senior Economic Journalist