Banks moves a few loans from EBLR to fixed rates in anticipation of 25 bps rate cut 

Reserve Bank of India

Banks are moving certain retail loan products from a variable rate of interest to a fixed rate in anticipation of a rate cut by the Reserve Bank of India (RBI) in the February monetary policy  under the leadership of the new governor Sanjay Malhotra. Bankers say this move will help protect their margins.

"Retail loans, which need not mandatorily be priced on external benchmark rates are being repriced as fixed rate loans," said a CEO of a PSU bank who didn't want to be named. Such retail products include car loans, two-wheeler loans, personal loans banks and small business loans where banks have the flexibility to choose whether they want to charge interest as per external benchmark rates of lending (EBLR) or as fixed rate loans.

Usually, whenever the central bank cuts rates, lending rates of banks, particularly on retail loans, reduce and as a result, it leads to compression in the margins. In order to protect net interest margins or NIM, which is a measure of banks' profitability, some banks have started moving to fixed rate retail loans, from variable lending rate or EBLR.

Meanwhile, bankers welcome the RBI's recent decision to cut the cash reserve ratio (CRR) in the just concluded December monetary policy. The move is expected to inject Rs 1.16 lakh crore into the banking system, which in turn could enhance the capacity of banks to lend and help in improving net interest income (NII).

Radhika Rao, Executive Director and Senior Economist at DBS Bank said the CRR cut could translate to a 2-6 basis points (Bps) improvement in domestic banks’ net interest income (assuming all funds are deployed for loans).

The move comes at a time when banks are facing the brunt of new norms on penal charges recognition. Interest income of the state-owned banks, for instance, took a 9-11 bps dent in Q2FY25 due to implementation of the new penal charges norms imposed by the RBI. 

As per the new norms, banks and non-banking finance companies cannot charge an additional sum to borrowers for missing loan repayments or breaking loan covenants as part of rate of interest computation. Should lenders charge borrowers for the same, it must be treated as penalties for non-compliance and accounted as “penal charges”. Penal charges, according to the latest RBI directive, cannot be charged to net interest income and should instead be classified as non-interest income.

Experts believe that with the injection of durable liquidity in the banking system due to CRR cuts in December, it could somewhat counter-balance the negative effect of penal charges on their interest income in the third and fourth quarter of this fiscal year.

Talks about the rate cut first started when India’s growth remained sluggish in the second quarter of the current financial year, and then after the lower inflation prints in November. The appointment of a new RBI governor Sanjay Malhotra replacing a pro-inflation handling governor Shaktikanta Das has also spurred hopes that the central bank may cut rates in the February 2025 monetary policy. This would be the last central bank policy for the current fiscal.

In Q2FY25, India’s GDP growth rate slowed down to 5.4 percent, hitting a seven-quarter low. Post the slowdown in GDP prints, the RBI revised its GDP growth forecast down 60 basis points for FY 2024-25 on December 6 and added that geo-political uncertainties and volatility in international commodity prices pose risks to the economic growth outlook.

GDP growth for the current financial year have been reduced to 6.6 percent from 7.2 percent earlier. The growth rate for the third quarter is pegged at 6.8 percent from 7.4 percent, for the fourth quarter, at 7.2 percent from 7.4 percent, for the first quarter of FY26, at 6.9 percent from 7.3 percent earlier and for the second quarter of FY26, at 7.3 percent.

In addition, lower consumer price index (CPI) print in November also increased chances of a rate cut. India’s retail inflation eased to 5.5 percent in November, easing from a 14-month high of 6.2 percent in the previous month, as food prices cooled off.

“We expect inflation may fall towards 5.2-5.3 for December 2024. With inflation expected to soften going ahead, it opens up space for RBI for policy easing to support growth,” said Akhil Mittal, Senior Fund Manager - Fixed Income, Tata Asset Management.