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The external benchmark-based lending rate (EBLR) system of loan pricing, calibrated normalisation of surplus liquidity and robust credit growth strengthened the monetary policy transmission during the current rate tightening cycle, according to an article in the Reserve Bank of India’s (RBI’s) monthly bulletin.
Monetary policy in the country moved into a tightening mode in May 2022 amidst inflationary pressures emanating from the conflict in Ukraine, rise in international commodity prices, disruption of supply chains and volatility in global financial market.
Between May 2022 and February 2023, the RBI raised the repo rate – the rate at which the RBI lends money to banks to meet their short-term funding needs – by 250 basis points (bps). One basis point is one-hundredth of a percentage point.
“Transmission to banks’ lending and deposit rates has improved in the recent period, facilitated by the introduction of the external benchmark-based lending rate system,” the article – Monetary Policy Transmission in India: Recent Dynamics – published in the November monthly bulletin of the RBI said.
The calibrated normalisation of surplus liquidity and robust credit growth strengthened transmission during the current tightening phase although it is still not complete, it said. The article has been authored by Yuvraj Kashyap, Avnish Kumar, Anand Prakash and Shubhangi Latey of Monetary Policy Department. The RBI said the views are of authors and not of the central bank. The RBI had mandated banks to link all retail loans and floating rate loans to micro and small enterprises (MSEs) to an external benchmark – the repo rate or 3-month T-bill rate or 6-month T-bill rate or any other benchmark market interest rate published by Financial Benchmarks India Private (FBIL), effective October 1, 2019.
In response to the cumulative hike in repo rate by 250 bps during May 2022 to October 2023, banks revised their repo-linked benchmark rates upwards by the same magnitude. The one-year median marginal cost of funds-based lending rate (MCLR) rose by a relatively lower magnitude of 152 bps, reflecting the trends in banks’ cost of borrowings. Consequently, the weighted average lending rate (WALR) on fresh rupee loans rose by 187 bps, while that on outstanding loans rose by 111 bps during May 2022 to September 2023, the article said.
At bank group level, the increase in the WALRs on fresh rupee loans was higher in the case of public sector banks (PSBs) relative to private banks (PvBs) during the period May 2022 to September 2023. The transmission to term deposit rates has been robust while savings deposit rates have exhibited rigidity, it said. In the current tightening cycle, with the sustained robust credit demand amidst tepid growth in deposits in the initial phase and moderation in surplus liquidity in the banking system, banks increased their term deposit rates significantly to attract fresh deposits, the article said.
During May 2022 to September 2023, the weighted average domestic term deposit rate (WADTDR) on fresh deposits (bulk and retail combined) increased by 229 bps as against the increase of 250 bps in the repo rate. The article said that an empirical bank-level analysis in a panel framework indicates that surplus liquidity in the banking system and a higher share of CASA (current account savings account) deposits in total deposits has a negative and significant impact on lending rates, while higher capital adequacy ratio has a positive and significant impact on lending rates.
High credit/deposit ratio strengthens the transmission to deposit and lending rates while excess SLR lowers the pass-through to deposit rates. With the MCLR-linked loans still a sizeable part of the lending portfolio, the transmission of the policy rate actions to deposit and lending rates is ongoing at the current juncture, the article said.
