Why the hype on banks cutting lending rates is a non-event for the average home loan borrower

State Bank of India (SBI), the country’s largest lender, recently slashed its external benchmark based rate (EBR) by 25 basis points (bps) to 7.8 percent per annum from 8.05 percent earlier, effective January 1. One basis point is one hundredth of a percentage point. The latest reduction make SBI’s home loan rate the lowest among major lenders in the industry.

In theory, borrowers should be rejoicing. And many headlines in the media are terming SBI’s rate cut as a big bonanza for the home loan borrowers in the form of cheaper equated monthly instalments (EMIs). But on a closer look, it is evident that home loan borrowers have little to be excited about.

Consider a borrower who has taken a Rs 20 lakh home loan for 20 years. A back of the envelope calculation using the SBI’s recent cut as the basis, shows that the borrower’s EMI will reduce to Rs 16,605 from Rs 16,916 earlier. In other words, the borrower is going to save just Rs 311 monthly on account of this rate cut. For a loan size of Rs 40 lakh, the saving would be Rs 622. While a saving nevertheless, it would be a stretch to call it a ‘relief’.

Now this is only for SBI. Other banks typically follow SBI cues but may go for smaller rate cuts. In most cases, banks may choose 10-15 bps to save their margins. This, using the above calculation, would mean the monthly savings of the borrower will be even less. Many banks had cut their MCLR rates by 10-15 bps after RBI kept the policy rate unchanged in the last policy review.

Remember, banks have been extremely hesitant to pass on the benefit of RB rate cuts to the end-borrower.

In the current rate cut cycle, the RBI has cut its repo rate -- the rate at which it lends short-term funds to banks -- by 135 bps, whereas even banks like SBI has at best passed on about 65-70 bps. If one look at the industry average, this figure could be actually 40-45 bps. Remember, the EBR isn’t the final rate at which banks lend money to the home loan borrower. Banks add premium to individual borrower depending their risk profile and there will be a reset clause on rates as well. All this means, the final rate at which a home buyer get money will be higher than what is advertised.

Eager to protect their net interest margins (NIMs), banks have largely ignored RBI’s calls for monetary policy transmission. NIM is the difference between interest earned and interest paid out. Even during the time of D Subbarao at RBI, the central bank and banks have scrapped on the issue of inadequate monetary policy transmission.

One other way of to understand how rate cuts doesn’t mean much to the borrower is to look at the trend in the home loan market. According to RBI data, in the first eight months of this fiscal, home loan growth has actually declined to 9.9 percent as against 10.6 percent in the corresponding period in the previous fiscal.

This was the period when many banks began cutting their lending rates in small quantum. If the rate cuts translated into meaningful benefits for home loan buyers, loan growth should have picked up commensurately.

The problem here may not be the cost of home loans; rather it is the cost of real estate.

“Until property prices correct significantly, it is very difficult to revive demand in the residential real estate market. Lending rate cuts can be an enabler for revival, adding to positive sentiments and a directionally positive move but isn’t the decisive factor,” said Siddarth Purohit, analyst at SMC Global Securities.

According to Purohit, unless the real estate cartels are willing to cut prices by at least 30-40 percent, it is difficult to bring back demand to the residential real estate segment. This is also true for corporations, where capacity utilisation is the bigger cause of concern than interest costs.

With the economy in a downturn, there are not enough takers for the goods produced by firms.

The economy grew at 4.5 percent in the second quarter, performing even worse than the 5 percent growth logged in the first quarter. There aren’t signs of a strong rebound as of yet.

The bottomline is this: Banks will have to slash their lending rates by another 30-40 bps from the current level, if the common borrower needs to benefit on his monthly EMI burden in a meaningful manner. Marginal rate cuts make for good headlines, but doesn’t help anyone.