On Wednesday, State Bank of India (SBI), the country’s largest bank with almost a quarter share of the banking business, linked its interest rates on savings bank deposits and short term loans to the repo rate of the Reserve Bank of India (RBI). SBI went ahead even though RBI had deferred the plan to link the rate of interest to external benchmarks like the repo rate or Treasury Bill rate following opposition from other banks.
What does this mean for SBI’s customers?
The bank has linked savings bank deposits with balances of more that Rs 1 lakh to the repo rate, changing from the practice of linking to the Marginal Cost of Funds based Lending Rate (MCLR).
The repo rate — the interest rate at which the RBI lends funds to banks — is currently 6%.
As per SBI’s formula, the new rate for savings bank deposits above Rs 1 lakh and up to Rs 1 crore will be 2.75% below the current repo rate — which works out to 3.25% per annum, as against the 3.5% offered so far.
For savings bank deposits above Rs 1 crore, the new rate will be 3.75%, down from the earlier rate of 4%.
All cash credit accounts and overdrafts with limits above Rs 1 lakh will be linked to the repo rate (current repo rate of 6% plus a spread of 2.25%), the bank has said. Risk premiums over and above this floor rate will be based on the risk profile of the borrower, as is the current practice.
How will small depositors and small borrowers be impacted?
Savings account deposits with balances less than Rs 1 lakh will continue to earn 3.5% interest — the same as the old rate fixed for these accounts. This interest rate is also subject to change by the bank as per RBI rules, but it will not be reset automatically as the repo rate moves.
Once the savings bank deposits cross the Rs 1 lakh mark, the lower interest rate will be automatically applicable. There is relief for small borrowers with cash credit or overdraft limits up to Rs 1 lakh, as they will not be linked to the repo rate.
What is the purpose of linking interest rates to an RBI benchmark rate?
In its December 2018 monetary policy meet, which was also the last policy of former Governor Urjit Patel, the RBI had proposed the benchmarking of fresh floating-rate retail loans and loans to micro and small enterprises to an external benchmark like repo rate or Treasury Bill rate, effective April 1, 2019.
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 substantial change.
The new system of external benchmark is expected to bring in more transparency in fixing interest rates, and faster transmission of rates. Banks were lagging in these two crucial factors while determining their deposit and lending rates.
Why did RBI defer the plan in its April policy?
On April 4, the RBI announced that it has put on hold its proposal to link interest rates on deposits and short-term loans to an external benchmark like the repo rate or Treasury Bill “taking into account the feedback received during discussions held with stakeholders on issues such as management of interest rate risk by banks from fixed interest rate linked liabilities against floating interest rate linked assets and the related difficulties and the lead time required for IT system upgradation”.
Many banks were lobbying against linking loans to an external benchmark rate, fearing a fall in margins. The repo rate lacks a term structure and banks have limited access to funds at repo rate, a banker said. They had taken the matter up in the bankers’ meeting with RBI Governor Shaktikanta Das.
According to a FICCI-IBA Survey of Bankers, spreads kept by banks under the proposed external benchmarking of new floating rate loans could be higher to protect themselves adequately in case of high volatility of benchmarks. Lack of depth in T-Bill and CD (Certificate of Deposit) markets can make such benchmarks potentially susceptible to manipulation, the survey said.