Indian financial system is dominated by banks. The success of RBI’s monetary policy to a large extent depends upon transmission of policy rates to banks’ lending rates. Earlier, the banking sector as a whole was blamed for slow/limited transmission of policy rates to banks’ lending rates.
During the recent past, in tune with the policy rate reduction, interest rates are coming down in the entire financial sector especially in banking. The minutes of the Monetary Policy Committee meeting published on February 20 mentions that the transmission of policy rate reduction has been full across various money and bond market segments.
“Transmission to the credit market has improved in the recent period. As against the cumulative reduction in the policy repo rate by 135 bps since February 2019, the 1-year median marginal cost-based lending rate (MCLR) has declined by 55 bps; the weighted average lending rate (WALR) on fresh rupee loans by 69 bps and the WALR on outstanding rupee loans by 13 bps.”
Banks’ lending rates primarily depend on the Marginal Cost-based Lending Rate (MCLR). The MCLR is revised every month based on the Marginal Cost of Funds, Negative Carry on Cash Reserve Ratio, Operating Cost and Tenor Premium/Discount.
Banks have to factor the level of bad assets while pricing their assets. The marginal cost of funds is the main component of MCLR. For borrowers, the effective rate will be MCLR plus spread levied by individual banks.
As per RBI statistics (lending rates of SCBs dated February 3), during the last three years (December 16 to 19), RBI Repo Rate has come down from 6.25% to 5.15%, a reduction of 1.10%. During the corresponding period median one-year MCLR of SCBs has declined from 9.15 to 8.3 registering a fall of 85 bps. The reduction in PSBs was sharper from 9.30 to 8.3 – reduction of 100 bps, whereas in the private sector banks, the reduction was only 0.27 (from 9.45 to 9.18).
The reduction in MCLR will have more impact in fresh rupee loans as the interest rates are normally linked to MCLR as on the date of disbursements. At SCBs level, Weighted Average Lending Rates on fresh rupee loans has declined by 2.17% during the last five years – 11.45 % (Dec. 14) to 9.28 % (Dec. 19).
However, the decline was 2.08% in private banks (12.09% to 10.01%) and in PSBs 2.47% from 11.27% to 8.8%. As of December 2019, the lending rates on fresh rupee loans in private banks are higher by 1.21% when compared to PSBs.
[Note: From October 1, 2019, banks have benchmarked floating rates to external rates (mostly Repo Rates) to the floating rate loans to new personal or retail loans and Micro and Small Enterprises (MSEs) and reset of rates happens on quarterly rates – instead of yearly. And, RBI has announced that from April 1, floating rates loans extended by SCBs to medium enterprises will also be linked to external benchmarks]
The reduction in lending rates may not be more in outstanding rupee loans as these loans are priced at the rates prevailing at the time of disbursements. If the loan is under fixed rates, the interest rate fixed continues till the completion of re-set period, if any. If the loans are on floating basis (linked to MCLR), generally the re-set happens on yearly basis and there is a time lag in rate reduction.
Rupee loans
The reduction in rates, even in outstanding rupee loans, is more in PSBs - the rate has declined from 11.68% to 9.6% (December 2014 to December 2019), whereas in private banks, it was a little lesser from 12.34% to 11.06% and at SCB level from 11.84% to 10.14%.
The interest levied on outstanding rupee loans is more by 1.46% in private banks when compared to PSBs. The sharper reduction in lending rates in PSBs may be on account of persuasion/compulsion from government/RBI.
When lending rates come down, banks have to reduce the rates offered to deposits to maintain banks’ Net Interest Margin. Both Current Accounts (nil interest) and Savings Deposits (3.5%+ interest) are insensitive to price and there are limits to mobilisation. Term deposits, to a great extent, are interest sensitive.
Term deposits are on fixed rates and re-pricing happens only on maturity/fresh deposits. Despite higher rates offered under various small savings scheme, better returns in Debt Schemes of Mutual Funds etc (some with tax benefits), banks are compelled to reduce term deposit rates.
At SCB level, the weighted average domestic term deposit rates have declined from 8.64% in December 2014 to 6.55% in December 2019. The decline was more in PSBs at 2.17% (from 8.67% to 6.5%) compared to private banks at 1.91% (from 8.73% to 6.82%). The happiness of borrowers on account of reduction in rates is certainly at the cost of the depositors.
Judged by reduction in interest rates on fresh/outstanding rupee loans, PSBs have done much better in rate transmission when compared to private banks as well as at SCB level. Correspondingly, the rate reduction in term deposits is more in PSBs.
(The writer teaches banking at ICICI Manipal Academy, Bengaluru)