It is often seen that banks are slower in passing on the repo rate cut to lending rates but are quick to pass on the hikes
Banks have passed on interest rates to loan borrowers at the fastest rate from June to August, but deposit rates have moved slower.
“Of the various tenors, the transmission of the policy rate hikes in June and August was the highest to lending rates of one-year tenor, with foreign banks in the lead,” said the Reserve Bank of India (RBI) in its monetary policy report.
On a hike of 50 basis points (bps) in repo rate since June, commercial banks have passed on 22 bps in median MCLR with foreign banks passing on 38 bps, private banks at 30 and public sector banks at 20 bps for a one-year maturity.
This also comes at a time when the Supreme Court of India, on October 8, directed the central bank to communicate its decision on the representation over banks delaying passing on the benefit of lower interest rates to those who have taken loans at floating interest rates.
It is often seen that banks are slower in passing on the repo rate cut to lending rates but are quick to pass on the hikes.
“The logic is that banks are in the arbitration business. Amid the bad loan trouble, they are operating on wafer-thin margins right now. Banks also play with the margin or the spreads on the rates which ideally they should not do,” said a financial expert.
The expert adds, “Even if they implement a fall (of 25 bps) in interest rate with a delay of even one month, they earn extra say 0.25 percent on their interest income. On a book of, say, Rs 10,000 crore, this comes to Rs 25 crore a year, which is over Rs 2 crore monthly addition to the profits.”
Within six weeks, the Supreme Court has asked RBI to submit its decision to public trust ‘Moneylife Foundation’ which had filed the representation alleging that banks and financial institutions take tardy approach in lowering interest rates despite the central bank’s reduction in the repo and reverse repo rates.
Slow deposit rate hike
“As per latest data by RBI, term deposit rates maintained slow upward trajectory in August 2018. Term deposit rates had seen a strong upward movement from November 2017 to March 2018 by 20 bps to 6.7 percent but were flat thereafter with marginal 11 bps rise until August 2018 to 6.8 percent, “ said a Kotak institutional equities report.
A senior public sector banker said, during base rate regime, banks were not willing to give up margins. “However with the MCLR or marginal cost based lending rate, banks are forced to pass on interest rates if their cost of funds come down, it is a calculation methodology...Banks are also facing pressure on margins and cost of funds have not come down as much given the stress due to non-performing assets (NPAs).”
On October 5, the MPC decided to keep key policy interest rate (repo rate) unchanged at 6.50 percent.
“Even before the MPC (monetary policy committee) raised the policy rate in June 2018 (by 25 basis points), banks had been increasing their term deposit rates from December 2017 in response to the waning of surplus liquidity in the system. The rise in term deposit rates exerted upward pressure on the cost of funding of banks in Q1:2018-19 and fed into the marginal cost of funds based lending rates (MCLRs) of banks,” the RBI report said.
MCLR is the lending rate offered by banks after April 2016. Prior to that, loans were pegged against a base rate.
Policy rate cuts and hikes
The RBI undertakes bi-monthly monetary policy review and sets the repo rate — at which it lends money to the banking/financial system, setting the tone for the interest rate regime which impacts, among others, EMI for home and auto loans.
At its peak in this cycle, the policy rates were at 8 percent in January 2015 after which it was on the decline.
Since January 2015, RBI had reduced the repo rate by 200 bps and the transmission of rates stood in the range of 80 bps (loans on base rate) to 205 bps (fresh loans).
After peaking in January 2017, there has been a marked decline in the interest rate spread between WALR (weighted average lending rate) on fresh rupee loans and the one-year MCLR during 2017-18 and 2018-19 so far.
This reflected the lack of pricing power among banks as well as some risk aversion as they shifted their exposure away from sectors with high NPAs (non-performing assets) to less-risky sectors,” RBI said in the report.
From April 2016 to May 2018, the RBI reduced repo rate by 75 bps and the pass on of these rates stood at 20 bps on base rate and 107 bps on fresh loans.
This also shows some improvement in rate transmission after the implementation of the MCLR regime, which means only new customers benefit.“We are facing a unique situation where lending is skewed towards some banks while deposit accretion is broadly spread across the space. This is pushing private banks to increase rates to borrow funds while passing them is still a challenge, though the trend shows improvement," the Kotak report added.