Banks peeved with RBI's latest nudge to cut lending rates

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Nazim Khanmoneycontrol.com

The Reserve Bank of India’s (RBI) decision to stay away from cutting the benchmark interest rate at its monetary policy meet today was driven in part by the fact that commercial banks are still yet to transmit the impact of the previous two rate cuts earlier this year into their lending rates.

“Transmission of policy rates to lending rates has not taken place so far despite weak credit off take and the front loading of two rate cuts,” the RBI said in its policy statement. “With little transmission, and the possibility that incoming data will provide more clarity on the balance of risks on inflation, the Reserve Bank will maintain status quo in its monetary policy stance.”

The transmission issue has been one that has often produced sharp reactions, when bankers concerned are asked why lending rates aren’t coming off soon enough. But before that, here’s how it works.

Since July 2010, the RBI has introduced the concept of base rate, or the minimum rate it will charge while lending to customers. (The base rate replaced the benchmark prime lending rate (BPLR), which had acquired a reputation for being non-transparent.)

However, while the central bank has given an indicative formula for individual banks to calculate their base rates: depending on its average cost of funds, overhead costs and profitability.

Base rates, thus, are based on each bank’s individual borrowings profile, spread across the mix of low- or zero-interest CASA deposits, bonds or market borrowings.

But like its predecessor, the base rate too is becoming known for suffering from the same problem: not being sensitive enough to changes in the repo rate.

For instance, most banks have cut their deposits from anywhere between 25 and 50 basis points (0.25 to 0.5 percent) but barring a few, none have cut lending rates yet.

A recent Deutsche report highlighted the lack of sensitivity that was witnessed during the previous easing cycle between 2012 and 2013: while the RBI cut the repo rate by 125 basis points and the cash reserve ratio by 200 basis points, the final transmission into base rates was a mere 50 basis points.

Shift for calculation proposed

To be sure, there is a market mechanism that works to bring down rates. Once there is excess liquidity and low demand for loans due to high rates, banks will invariably pull the trigger to lower their lending rates in order to attract more borrowers.

But in order to nudge banks into moving on base rates sooner, the RBI today proposed a shift in the way it is calculated.

“In order to improve the efficiency of monetary policy transmission, the Reserve Bank will encourage banks to move in a time-bound manner to marginal-cost-of-funds-based determination of their base rate,” the RBI said. “Detailed guidelines will be issued shortly.”

The shift away from the current method – optional between average, marginal or blended cost – is expected reduce the lag period, as it would give greater weightage to newer, cheaper (or costlier) funds banks get following a repo rate cut (or hike).

But bankers had their doubts over its effectiveness, or whether such a move was desirable.

SBI chairperson Arundhati Bhattacharya said that banks have been usually reluctant to cut rates of deposits, which form the lion’s share of their borrowings. This causes a transmission lag.

“In the absence of a formal social security net, deposits serve as a proxy [for retirees looking for income]. Thus we have to take into account the needs of depositors,” she said at a conference of bankers post the policy review.

But when asked why the transmission lag is not visible when the RBI hikes repo rate, the SBI chief said banks were careful to not hike rates by as much as the central bank.

ICICI Bank CMD Chanda Kochhar that as deposit rates have been easing in the past few months, the effect should manifest itself in lending rates sooner rather than later.

“It is an easing rate cycle. Rates will come down though it is difficult to pinpoint exactly when and by how much,” she said.