RBI cuts repo rate by 25 bps to 6.25%, Deposit rate transmission to take two quarters

The transmission of recent rate cuts to deposit rates under the Net Cumulative Liquidity Ratio (NCLR) framework will be gradual, as many existing deposits are fixed with terms like five years, where no immediate changes will occur, according to Malhotra.

New deposits, however, will reflect these changes. The process will take time depending on the average tenure of deposits, but banks will ensure liquidity support. Regarding the Marginal Cost of Funds-based Lending Rate (MCLR), adjustments are typically made on a semi-annual basis, with many banks expected to revise rates between June and December, as noted by Malhotra.

The repo rate cut could lead to a Net Interest Margin (NIM) impact of 5-10 basis points, with public sector banks (PSU) experiencing relatively lower effects due to other variables like loan and deposit mix and Loan-to-Deposit Ratio (LDR), according to Rikin Shah, IIFL.

He also pointed out that the rate cut could inject significant liquidity into the system, benefiting banks, particularly those with lower Loan-to-Deposit Ratios (LDR).

However, unique factors for certain banks could lessen the NIM impact, such as HDFC benefiting from its interest rate swap book and replacing higher-cost borrowings with deposits, SBI's increasing LDR expected to reach about 98 percent thus mitigating NIM drag, and the gradual increase in higher-yielding MFI loans supporting the blended loan yields of IIB and RBL, he added.

Shah noted that the market has already factored in such a repo rate cut, and the actual impact might already be partially reflected in the rates.

NBFCs which traditionally fund their operations through equity, market borrowing, and bank finance, making up between 30 percent to 47 percent of their resources, J Swaminathan, Deputy Governor of RBI.
The transmission of rate cuts from the central bank has been more beneficial for AAA-rated Non-Banking Financial Companies (NBFCs) than for those rated AA, said Viral Shah, IIFL.

Specifically, AAA-rated NBFCs have seen their borrowing costs decrease by 11 basis points (bps), while AA-rated NBFCs have only experienced a 5 bps decline, he said, adding that this disparity has led to an 80 bps spread between AA-rated NBFCs and their AAA-rated counterparts, which is 20 bps higher than what is considered the Long-Term Average (LTA) during 'normal times'.

This spread is even more significant than during past crises like the taper tantrum or the IL&FS debacle, suggesting a notable divergence in how market conditions affect different credit ratings, he added.

Several factors contribute to this increased spread. Firstly, there's an accentuation of asset quality stress, particularly in pockets of retail loans for NBFCs with lower ratings, indicating that these companies might be facing higher levels of problematic or non-performing loans. Secondly, regulatory measures have imposed higher risk weights on AA-rated NBFCs, compelling them to hold more capital against their assets, which, in turn, increases their funding costs. Finally, the dynamics of demand and supply have shifted, with weaker-rated NBFCs increasingly turning to capital markets for funding, influenced by regulatory nudges towards more diversified funding sources. This situation has led to a scenario where the cost of funds for AA-rated NBFCs is significantly higher than for their AAA peers, reflecting the market's perception of increased risk associated with these institutions.

The new segment aims to moderate certain additional risks without the intention of halting any business activities. The focus remains on ensuring financial stability, as stated by the regulatory body.

Viral Shah from IIFL highlighted that the market has already anticipated a rate cut, with benchmark government securities yields dropping and liquidity conditions easing. He discussed the differential transmission of rate cuts among NBFCs, suggesting that a staggered 50 basis points reduction over the next six months could lead to varied impacts on different NBFCs' Cost of Funds (COF) and NIMs.