Repo-linked deposit rates: A tiny half-step
On Friday, March 8, State Bank of India (SBI) announced that starting May 1, savings bank account deposits and short-term loans (overdraft and cash credit) above ~1 lakh would be linked to the Reserve Bank of India’s (RBI’s) repo rate from. (Repo is the rate at which the central bank lends money to banks when they face shortage of funds.)
Every single commentator I read has hailed the move as a logical next step, after the RBI asked the banks in December last year to link all new floating rate retail loans like home loans with an external benchmark from April
1, 2019. Any careful observer will immediately notice that what the central bank wanted and what SBI has done are far apart.
SBI has linked deposit rates to repo rates (thereby making them floating, from fixed). But it has not announced the linking of lending rates of longer-term loans for businesses and retail customers of home loans, personal loans, auto loans, etc. to make these true floating rates. For borrowers affected by the opaque and discriminatory practices of banks, the loot will continue. Remember that under Urjit Patel as governor, the RBI had announced that banks would have to link lending rates to an external benchmark, but, under the new governor, it is showing no hurry to take this forward. In fact, it almost seems certain that April 1 will come and go and banks will be let off again. That would be in line with RBI’s repeated failure to ensure a proper transmission of interest rates where a reduction in the interest rate by the central bank would ensure lower rates across the system and vice versa. Will SBI’s move help the RBI’s objective of improving transmission? Consider this:
1. Banks have been claiming that since the bulk of the deposits is fixed, they do not have the flexibility for transmission. How much of bank deposits are in savings accounts? For SBI, savings account deposits make up 38 per cent of the total. Of this 20 per cent are below ~1 lakh. This means that only 80 per cent of 38 per cent, that is 30 per cent of deposits, will be floating. So, 70 per cent of deposits will remain fixed, which would continue to hamper the ability of banks to implement a true floating rate regime.
2. What would be the impact on the bank’s marginal cost of lending rate (MCLR)? A 25 bps reduction in the interest rate on these deposits could lead to a reduction of only 7 bps in the bank’s MCLR with this move. It is better than before but only a very tiny step.
3. In any case, SBI taking a tiny halfstep forward won’t mean much for the system as a whole, unless the rest of the banks follow SBI. According to media reports, most other banks are not likely to do so.
4. According to one interpretation, after the savings account is repolinked, part of such deposits will get converted into fixed deposits. If so, even less of the deposits would be repo-linked, reducing the transmission even further.
Deposits: The false bogey
There are two critical factors being missed in this debate. One, while banks are making a song and dance about the fact that their liability side is not floating, the real issue is the spread. In the debate on transmission, there is surprisingly no discussion on what other factors go into deciding the spread, and thereby the lending rates of banks. For the MCLR, the RBI methodology includes three more factors other than the cost of deposits/funds: Negative cost of carry on the cash credit ratio and statutory liquidity ratio; unallocable overheads which left enough scope for banks to show a higher figure by not being clearly defined; and average return on net worth, which is another figure that banks can fudge. Even experts blame the inflexible cost of deposits (funds) as the only hindrance to transmission. There is no scrutiny of the other three factors that determine the MCLR. The RBI has also played along with this farce.
Two, the biggest impediment to public sector banks (PSBs) not being able make their lending rates truly float is irresponsible, indiscriminate and corrupt lending that has created a mountain of bad loans. This has made them bankrupt, requiring public money to be pumped in to revive them, over and over again. Unaccountable bankers have hampered the PSBs’ ability to lend and this has kept lending rates high, while they blame a distant factor such as inflexible deposit rates for lack of transmission.
The transmission of interest rates has failed miserably for 20 years, partly because of poorly designed policies and partly due to the benign negligence of the RBI. Banks are focused on their bottom line and not on transmission. Transmission reduces their profits and, hence, is not a concern to them. SBI could have made its deposit rates floating anytime since 2011 when the RBI policy allowed it to do so. But it didn’t. It has acted now, under pressure, as a nod in the direction mandated by the RBI. If transmission has to succeed, we need a clear set of guidelines that do not allow banks to fudge internal calculations to cheat borrowers, and continue with the status quo.