Follow Us:
Wednesday, January 29, 2020

Explained: Despite RBI’s temporary pause, borrowing cost may still fall as spread narrows

As uncertainties surround the financial system — especially in the backdrop of failure of large institutions like IL&FS, DHFL, PMC Bank and some smaller NBFCs — banks are yet to fully pass on the rate reductions to customers.

Written by Sunny Verma | New Delhi | Updated: December 7, 2019 8:23:17 am
Reserve Bank of India Governor Shaktikanta Das Reserve Bank of India Governor Shaktikanta Das

The Reserve Bank of India’s decision to not lower its repo rate, against the consensus forecast of a 25-bps cut, can be seen in the backdrop of significant scope for banks to pass on the past reductions in policy rates to customers.

While interest rate transmission has been sharp in short-term money and wholesale loan markets, retail borrowers are yet to experience reduction in commercial lending rates of banks that is commensurate with the rate actions of the RBI. In fact, the weighted average lending rate (WALR) of scheduled commercial banks between December 2018 and October 2019 actually increased by 5 basis points (bps) against a cumulative policy rate cut to the tune of 135 bps, as per the latest available data with the RBI.

The spread between the repo rate and WALR of banks is at its peak since the RBI data is available from March 2012. As on October 2019, spread — or mark up of WALR over repo rate — was as high as 5.25 percentage points.

The spread was lowest in September 2018 at 3.82 per cent. In September 2018, which is also the month when IL&FS started defaulting on loans resulting in a spiral effect in the credit markets, the WALR of banks was 10.32 per cent while the repo rate was 6.50. In contrast, in October 2019, the WALR is 10.40 per cent even though repo rate has fallen to 5.15 per cent.

As uncertainties surround the financial system — especially in the backdrop of failure of large institutions like IL&FS, DHFL, PMC Bank and some smaller NBFCs — banks are yet to fully pass on the rate reductions to customers.

Analysts note that the pause in rate reductions is because RBI is hoping that transmission of rates will improve going forward.

RBI Governor Shaktikanta Das said the pause was temporary and the central bank wanted to assess the effect of its policy after rate reduction in five policies this year. He said “there is space available for further monetary policy action” and there is also a need to “maximise the impact of rate reductions”. In its monetary policy statement, RBI said the transmission has been fastest in money markets and WALR on fresh rupee loans declined in recent months.

During February-October 2019, when RBI cut its repo rate by 135 bps, transmission to various money and corporate debt market segments ranged from 137 bps (overnight call money market) to 218 bps (three-month CPs of non-banking finance companies). Transmission to the government securities market, however, has been partial at 113 bps (five-year government securities) and 89 bps (10-year government securities), the RBI said. The one-year median marginal cost of funds-based lending rate (MCLR) has declined by 49 bps.

However, it is the WALR which remains sticky, indicating that rate reductions have been muted for bulk of retail borrowers. “The WALR on fresh rupee loans sanctioned by banks declined by 44 basis points, while the WALR on outstanding rupee loans increased by 2 basis points during this period,” the RBI said.

“However, transmission is expected to improve going forward as (i) the share of base rate loans, interest rates on which have remained sticky, declines; and (ii) MCLR-based floating rate loans, which typically have annual resets, become due for renewal,” it said. The median term deposit rates of banks have also declined by 47 bps during February-November 2019, which augurs well for transmission to lending rates, going forward.

Don’t miss from Explained | Holding rates of interest: RBI cites inflation which raises questions

For all the latest Explained News, download Indian Express App

0 Comment(s) *
* The moderation of comments is automated and not cleared manually by indianexpress.com.
Advertisement
Advertisement
Advertisement
Advertisement