State Bank of India, the largest commercial bank in the country, has decided to link interest rates on savings bank deposits and short term loans, including personal loans, to the Repo rate of the Reserve Bank of India (RBI). The new interest rate system, which is expected to speed up interest rate transmission and transparency in the banking system, will come into effect from May 1, 2019.
Kicking off the new rate system, SBI has decided to link savings bank deposits, with balances above Rs 1 lakh to Repo rate with current effective rate being 3.50 per cent per annum (2.75 per cent below current Repo rate of 6.25 per cent). The bank has announced that all cash credit accounts and overdrafts with limits above Rs 1 lakh will be linked to the Repo rate (current Repo rate 6.25 per cent plus a spread of 2.25 per cent). The risk premiums over and above this floor rate of 8.50 per cent would be based on the risk profile of the borrower, as is the current practice, SBI said.
Other lenders set to follow the new era in banking system
The RBI experimented with several systems like base rate, MCLR and BPLR to price loans but failed in bringing in transparency and speedy transmission of policy rate movements. Banks also found it convenient so far to cling on to opaque systems to rake in profits at the cost of customers. With SBI implementing the RBI directive to link interest rates to an external benchmark Repo rate and others set to follow the leader, the banking system is set for a new era of more openness and faster rate transmission.
In order to insulate small deposit holders and small borrowers from the movement of external benchmarks, SBI has decided to exempt savings bank account holders with balances up to Rs 1 lakh and borrowers with CC/ OD limits up to Rs 1 lakh from linkage to the Repo rate. Other banks, which were lobbying against the new system, are set to follow suit in the coming weeks. Repo rate is the rate at which the RBI lends funds to banks.
In its December 2018 monetary policy meet, the RBI had proposed benchmarking of fresh floating-rate retail loans and loans to micro and small enterprises to an external benchmark like Repo rate or Treasury Bill’s rate, effective April 1, 2019. Many banks, lobbying against linking loans to an external benchmark rate fearing a fall in margins, had taken up the issue in the recent meeting with RBI Governor Shaktikanta Das.
According to the RBI, the spread over the benchmark rate — to be decided at banks’ discretion at the inception of the loan — should remain unchanged through the life of the loan, unless the borrower’s credit assessment undergoes a substantial change. “Banks are free to offer such external benchmark linked loans to other types of borrowers as well. In order to ensure transparency, standardisation and ease of understanding of loan products by borrowers, a bank must adopt a uniform external benchmark within a loan category,” the RBI had said in December 2018. In other words, the adoption of multiple benchmarks by the same bank is not allowed within a loan category.
Anil Gupta, vice president, ICRA, said, “despite the recent cut in Repo rate, banks were struggling to reduce their lending and deposit rates as the deposit accretion continued to lag credit growth. Cutting deposits rate was not a feasible option for banks amid slowing deposits growth. Linking the savings deposit rate with policy rate will help faster repricing of liabilities for banks and help in protecting their profit margins.” “We expect more banks especially all the public sector banks and few large private banks to follow the move by linking their deposit and lending rates to Repo rate which will also be in line with RBI requirements to link these rates to external benchmarks,” Gupta said.
The new system is expected to bring in more transparency in fixing rates and faster transmission of rates said an RBI official. Banks were lagging in these two crucial factors while determining their deposit and lending rates.