Interest rates on deposits are likely to ease further going ahead after the Reserve Bank of India (RBI) skipped policy rate cut and introduced liquidity boosting measures to support growth. While transmission of the lower cost of funds is expected to bring down lending rates, it may not be enough to revive credit demand.
On February 6, the RBI allowed banks to exempt incremental loans given for housing, auto and MSMEs between a six-and-a-half month window ending July 31 from the calculation of Cash Reserve Ratio (CRR). The move was aimed to bring down banks’ cost of funds so that the benefit can be passed on to borrowers.
“The CRR exemption will help in reducing cost on incremental loans, so naturally the benefit will be passed on,” said Rajkiran Rai G, MD & CEO, Union Bank of India. He added that the impact is likely to be nominal due to this measure as new home loans are linked to the repo rate under the external benchmarking framework.
CRR is the amount of cash that banks are mandatorily required to set aside with the RBI. Currently, it is at 4 percent of net demand and time liabilities (NDTL). It has a negative carry for banks as they do not earn any interest on CRR.
“We are working on how these measures can be priced into our products and have sought clarification on technical details such as how will it apply to home loans where disbursements take place over a 30-year tenure,” said a senior official from a state-run bank.
“There will be some impact on lending rates as short-term rates are likely to remain low going ahead. Also, there is sufficient liquidity in the system and most banks have abundant deposits. The benefit from lower deposit rates will be transmitted gradually,” the official added.
Banks have been reducing rates on fixed deposits across tenures over past few months. As a result, the cost of funds, that ease gradually as deposits mature, have come down by around 30 basis points over a year.
Rai expects deposit rates to further ease by 20-25 basis points over the next 3-4 months.
RBI also introduced Long Term Repo Operation (LTRO) to inject Rs 1 lakh crore via 1-year and 3-year fixed rate repo auctions. The move was aimed at bringing down short-term rates in the money market initially, leading to lower corporate bond yields, deposit rates and lending rates eventually.
“The term repo auctions which RBI has announced will reduce costs in 1-year and 3-year maturity. When that happens, deposit rates will be further cut and transmission in MCLR will happen,” Rai added.
However, there is uncertainty whether these measures will help revive credit growth that has been trending near historic lows this year. Most lenders, both private as well as state-run, have pared their year-end credit growth targets by 2-3 percent due to sluggish demand and risk aversion.
“Since the banking system has been in massive surplus for the past eight months or so, further boost to supply (or liquidity) is unlikely to revive economic activity. Worryingly though, some lenders may be tempted to fund sub-prime projects or even evergreen loans, thus creating further concerns over the medium-term,” said Nikhil Gupta and Yaswi Agarwal, analysts, Motilal Oswal.
According to RBI data, Indian banks’ credit growth was at 7.2 percent as of January 17, compared to growth of 14.6 percent a year ago. This is despite a cumulative rate reduction of 135 basis points in five back-to-back policy reviews since February 2019.
“In a way, easing has resumed after a pause last time. Going ahead, we expect the RBI to resume policy rate cuts as well, especially as the central bank itself expects inflation to fall towards 3 percent by Q3FY21,” said Kapil Gupta, analyst, Edelweiss Securities.
RBI expects these measures to ensure faster transmission of past rate cuts and improved credit flow to troubled sectors of the economy.