Saikat Das
moneycontrol.com
The Reserve Bank of India (RBI) so far slashed the policy rate by 75 basis points to spur growth in 2013. However, banks have not yet started reducing their lending rates citing liquidity tightness. In the absence of prompt transmission, a shift of the policy rate from repo to reverse repo is seen as a key lubricant to ensure softening interest rates.
Repo is the rate at which banks borrow money from RBI. Reverse repo is the rate at which banks park their excess funds with the central bank. RBI assigns repo as the key policy rate and maintains a spread of 100 bps between repo and reverse repo.
"Lending rates will drop once operating policy rate shifts from repo rate to reverse repo rate," Moses Harding, head of asset liability committee and economic research at
IndusInd Bank told
moneycontrol.com.
"This means that the system liquidity should shift from deficit to surplus. When banks get the fear of lending their surplus funds to RBI at reverse repo rate, lending rates will drop and will also lead to pick-up in investments; hence the demand for CRR cuts for infusion of liquidity into the system," he said.
Also read: How banks will benefit from bond yield fall: Moses HardingCurrently, repo rate is at 7.25 percent and reverse repo is 6.25 percent. In its June 17 mid quarter policy, RBI is expected to cut the policy rate by another 25 bps. Be it 6.25 or 6 percent, banks will always prefer deploy the same fund in lending business at a discounted rate.
Banks are not allowed to lend below base rates.
HDFC Bank currently offers the lowest base rate at 9.65 percent followed by
SBI at 9.70 percent and
ICICI Bank at 9.75 percent. Lenders lend after adding a spread over and above the base rate. Hence, the reverse repo option is not viable for lenders, which will be rather interested to give relaxation to existing rates.
"We continue to expect the RBI to shift the money market to reverse repo mode from repo mode in the second half of 2013 only if normal rains - due this week - dampen agflation. After all, a 5 percent change in agflation impacts WPI inflation by 175 bps and CPI inflation by 250 bps. This, in turn, would provide the RBI greater headroom to arrest the collapse of growth," Indranil Sengupta, India economist at Bank of America Merrill Lynch said in a research report.
Agflation is a kind of generalized inflation driven by increases in agricultural commodity prices.
According to Sen, surplus money market liquidity is indispensable for lending rates to come down as the money market deficit helped to push up cost of credit. India is perhaps the rare economy wherein lending rates are at an elevated level as those were at peak in 2008.
Bank of America Merrill Lynch expects 75 bps cuts in lending rates across the industry in 2013-14. RBI will either hike the repo rate and pull up the reverse repo rate by 100 bps or narrow the current repo-reverse repo rate corridor of 100 bps.
"A shift should give more space for banks to lend. RBI will have limited option by the second half of the year but to do it. Industry expects the central bank to shift to reverse repo. Any other available options like cut in the bank rate will directly impact banks' profitability," said Navin Raghuvanshi, vice president –
Development Credit Bank.
After the introduction of base rate, the bank rate, which is stands at 8.25 percent, apparently lost relevance. However, any reduction in the rate exert pressure on banks to cut loan spreads. This in turn, will squeeze bank net interest margins.
saikat.das@network18online.com 
