The decline in interest rates on old loans has failed to match the transmission in rate reduction in fresh loans after demonetisation, a Reserve Bank report has said.
This means as much as 67 per cent of the existing credit portfolio has not benefitted much from the interest rate decline witnessed after demonetisation. During November 2016 — February 2017, the weighted average lending rate (WALR) of banks in respect of fresh rupee loans declined by 69 bps, whereas the WALR on outstanding rupee loans declined by 13 bps only over the same period, the RBI said in ‘Monetary Policy Report April 2017’.
Banks cut their marginal cost of funds based lending rates (MCLRs) on new loans deeper than Base Rate which is applicable to 67 per cent of the existing credit portfolio after demonetisation.
According to the RBI, transmission to lending rates for outstanding rupee loans vis-à-vis fresh rupee loans has been limited essentially on account of two factors. “First, a major portion of loans contracted prior to the introduction of MCLR (April 2016) has continued to be priced at the base rate. In fact, loans contracted at the base rate still constitute about 67 per cent of banks’ loan portfolios,” it said.
“Second, even under the MCLR-based pricing of credit, the interest rate is typically reset on the existing loans on an annual basis, implying that most loans under the MCLR regime contracted up to December 2016 would not have benefited from the sharp reduction in the MCLR,” it said.
Monetary policy transmission strengthened in H2 of 2016-17, aided by the surfeit of liquidity, the RBI said. The share of low cost current account and savings account (CASA) deposits in aggregate deposits with the SCBs went up to 39.2 per cent (as on March 17, 2017) — an increase of 4.0 percentage points relative to the pre-demonetisation period. “Given the prevailing risk aversion, banks reduced their term deposit rates. The median term deposit rate and the weighted average domestic term deposit rate (WADTDR) fell by 37 bps and 32 bps, respectively, during November 2016-March 2017,” it said.
Combined with the sharp increase in CASA deposits, the overall cost of borrowings declined, creating space for banks to cut their MCLRs, the RBI said. The one-year median MCLR declined by a cumulative 70 bps since November 2016, even as the policy rate remained unchanged. This is significant, given that the decline during the preceding seven months (April-October 2016) — when the repo rate was cut by 50 bps — was only 15 bps. Post-demonetisation (up to March 2017), 27 public sector banks have reduced their one-year median MCLR in the range of 50 to 105 bps, and 19 private sector banks have done so in the range of 25 to 148 bps, it said.
The RBI’s analysis of factors hindering transmission using quarterly bank level data (for the first three quarters of 2016-17) suggested the presence of a positive correlation between the spread (WALR on outstanding/ fresh rupee loans over MCLR) and stressed assets of banks, implying that banks charge additional risk premiums on their performing assets to compensate for the interest income losses from NPAs. “Among the various components of the MCLR, it is only the term deposit rates that are seen to respond to the changes in policy rate,” the RBI said.
Another factor which has impeded monetary policy transmission is the interest rates on small savings which are not in alignment with movements in market interest rates, the RBI said. Although the government has announced to revise the interest rates on small savings in line with the change in G-sec yields, this is not fully implemented, it said.
“Demonetisation-induced surplus liquidity conditions also impacted the market micro structure, which had a bearing on volumes and rates. In the call money market, lending volumes of co-operative banks increased significantly,” it said. Their share in average daily call volumes rose to more than 50 per cent post-demonetisation (up to February 2017), from the average of 36 per cent during April-October 2016.
In view of surplus liquidity, banks reduced recourse to certificates of deposit (CDs), issuance of which declined sharply to Rs 40,700 crore and Rs 85000 crore during Q3 and Q4 (up to March 17, 2017) of 2016-17 as against Rs 144,600 crore and Rs 260,700 crore, respectively, during Q3 and Q4 of previous year.