'New base rate computation method can hit banks' profits'

The Reserve Bank is mulling changing the way base rates are computed by banks. The RBI issued draft guidelines on the computation of the same, based on marginal costs of funds, which may be effective from April 1, 2016. At the moment, banks pick any kind of cost of funds as a reference.RBI suggested the move in its first bi-monthly policy on April 7 in a bid to ensure that banks pass on policy transmission effectively. RBI has lowered repo rates by 75 basis points since January this year. But, banks are yet to lower their base rates by as much.

However, if implemented in its current form (draft guidelines), it may have a significant impact on profits of banks because return on assets (RoA) will fall by 20 basis points in fiscal year 2017, says Pawan Agrawal, chief analytical officer at Crisil Ratings. It has a base case of banks being hit by a one-time impact of around Rs 20,000 crore in fiscal year 2017, which would equal to 15 percent of total estimated profit of the banking system for that year.

The actual impact will depend on whether banks will be given a leeway to make shift over longer time frame in final guidelines, he says. For every subsequent 25 bps cut in deposit rates, profit will be impacted by Rs 5000 crore in a year, he told CNBC-TV18.Marginal costs of funds is the incremental cost of borrowing more money to fund more asset purchases or it can also be defined as the interest rate on the new loan balance.Despite all odds, it appears as though the industry is already moving towards marginal cost of funding. Romesh Sobti, MD and CEO, IndusInd Bank, says HDFC Bank's base rate cut is a forerunner to the new methodology of calculating base rates, which he believes may come quickly.

Meanwhile, the research report also states that banks can look at mitigating interest-rate risks by sourcing more short-term deposits and borrowings. However, the flexibility to do this will be limited given that they have to implement Basel III rules. But, banks can look at offering floating rate deposit products, but this would depend on demand, it adds.