RBI’s rate cut: Who benefits, not borrowers at least!
The Reserve Bank of India cut its repo rate by 25 basis points to 7.75 percent in a surprise move on 15 January, making its first reduction in the running year as inflation showed signs of calming down and the government showed urgency to contain the fiscal deficit. With retail and wholesale inflation rising at slower-than-expected rate of 5 and 0.11 per cent, the central bank finally obliged to the long-standing rate cut demand from the industry and national government – previous and incumbent.
With this lowering of interest rate, anticipation arises for further cuts in future as RBI has itself hinted towards the same, provided inflation scenario remains well adjusted to the corridors pre-fixed by the Urjit Patel committee.
However, the bigger question here’s not about the timing of rate cuts that may anyways arrive in coming months, but poor interest rate transmission mechanism followed by both private and public banks of the country. With this reduction in the base rate, all kinds of loans including housing and auto loan should become cheaper. But, considering the trend followed by banking sector for long, this rule finds difficult to be realized in a real sense any time soon.
What’s the reason?
After RBI’s rate cut earlier his year only two banks — Union Bank of India and United Bank of India— have cut their base rates. And these two banks also have only aligned their base rate with that of the other banks by cutting 0.25 basis points to 10 per cent.
Reluctance from banks continues
Banks – public and private – have been slow movers since years, in passing on the benefits of rate cut by the central bank to the borrowers despite several efforts from RBI to improve the situation. It just appears to be nothing but disdain of the monetary policy by the banks, rendering it as a step for ineffectual cause. Pitifully, Banks in the past have shown reluctance to pass on the benefits of rate cut, but have always been hands-on in raising the benchmark lending rate soon after the repo rate (the rate at which the RBI lends to banks) is hiked.
In one of the blog posts by Sandip Sabharwal, a well-known market expert, poor interest rate transmission scenario is higher in case of retail floating rates. He claims, “This is extremely high in the case of Retail Floating Rates given by banks where the transmission is 150% on the way up and 50% on the way down. For example statistics reveal that post 2008 crisis when RBI reduced rates by 525 basis points besides cutting CRR several times the average lending rate reduction by Indian banks was just 128 basis points.”
He further quotes an example: “For example when I took the loan the RLR would have been 10.5%, so I was at a 3.25% discount to that. In the tightening cycle of RBI they increased the RLR to 16.5% so my loan got repriced to 13.25%. However when the RBI cut rates they did not reduce the RLR as much but offered higher discounts to new customers. and ripped off the older ones.”
PSU banks still better placed
Taking into account data from the banking sector since 2008, public sector banks have transmitted the benefits of rate cut from the central bank more actively than the private sector banking institutions.
The RBI reduced rates by 425 basis points from September 2008 and September 2009 public sector banks followed with a 128 basis points cut. However, private sector banks only cut rates by a meager 60 basis points.
Similarly, from March 2012 and June 2013 public sector banks cut rates by 30 basis points and private sector banks raised loan rates by 30 basis points when RBI struck down repo rate by 125 basis points.
Reason for unwillingness to cut rates
Private sector banks find it difficult to cut rates for the reason they need to maintain their high Net Interest Margins as profits rule the roost for privately run institutions ultimately. They also need to price in future risks and also keep a track of prevailing spreads. They don’t also lower lending rates in a hurry just to maintain higher spreads which earn them business from depositors.
Amid this all, large corporate still manage to issue Commercial Paper (CP) and take advantage of rate cut, retail investors find nowhere to go. Most appallingly, banks themselves purchase the CPs and ultimately outwit the entire Base Rate mechanism.
However, situation this time is gloomier for these two reasons:
1. Slippage in credit growth rate
2. Increase in stressed assets
Conversely, RBI is no mood to let the banks escape unquestioned this time. The RBI has asked the banks to notify the Base Rate i.e. the minimum lending rate at least once in every three months based on the cost of funds. At least retail borrowers have something to cheer about here ultimately!