Finance ministry says ensuring transmission of repo rate cut by banks crucial

Though the Reserve Bank of India (RBI) has reduced the policy repo rate by 115 basis points since March to boost India's sagging economic growth, the finance ministry is concerned about the slow transmission rate.

"Lowering of interest rates is not the issue presently, and there is a case for RBI to reduce it even further. But the problem that needs to be addressed immediately is the transmission and what this rate cut is doing to spur demand," a senior government official told Moneycontrol.

The issue that needs to be addressed by all stakeholders right now is how to ensure that the benefit is passed on to where it's needed the most. "It has to be understood that these are long term structural changes. So, when people are ready to take the benefit of cheaper loans, it has to be available to them," the official said.

Between February 2019 and May 2020, though the cost at which banks borrow from the RBI fell by 225 basis points, the weighted average lending rate (WALR) - the interest rate paid by borrowers on bank loans - during the same period, has dropped by 151 basis points on the fresh loans and merely 37 basis points on existing loans.

Given the economic situation at present, banks are taking a conservative approach in retail lending, as uncertainty looms large over retail segment loans as the private sector grapples with pay cuts and job losses.

The RBI, however, has said transmission of interest rates in fresh floating rate loans has considerably improved after external benchmarks were introduced in October. Last year, the RBI asked banks to move all floating rate retail and small business loans to an external benchmark to quicken transmission of interest rates.

"There's another component that banks charge, apart from the cost of deposits and repo rate, a risk premium. This is based on an assessment made after studying a borrower's financial profile. Now, with the job losses and pay cuts denting incomes, banks have increased the risk premium. Everything together is pushing up the cost of loans," a banking sector analyst who did not wish to be quoted, said.

Banks in the country are likely to witness a spike in their non-performing assets ratio by 1.9 percent and credit cost ratios by 130 basis point in 2020, following the economic slowdown on account of Covid-19 crisis, S&P Global Ratings said in its report titled 'For Asia-Pacific Banks, COVID-19 Crisis Could Add $300 Billion To Credit Costs.'

The report said that the NPA ratio in India was likely to fare similarly to China's (1.9-2 percent) but the credit costs ratios could be worse, increasing by about 130 basis points.