WAITING FOR CHEAP LOANS
Why the RBI’s repo rate cuts have not translated into lower interest costs for borrowers
Though the Reserve Bank of India (RBI) has cut its benchmark rate several times this calendar year—by a total of 75 basis points, or 0.75 per cent—potential borrowers who have been waiting for a corresponding fall in interest rates will have to wait longer. According to an RBI policy statement issued on June 20, though the repo rate (the rate of interest the central bank charges commercial banks for loans) was cut by 0.5 per cent between February and April this year, banks passed on less than half that benefit to consumers in the same time period, with the weighted average lending rate for new loans reducing by only 0.21 per cent. Though this is a disappointing turn of events, there are some structural reasons that have prevented banks from passing on the benefit of RBI rate cuts to borrowers.
➘ THE COST OF FUNDS
Primary among the reasons for banks not reducing lending rates is the fact that these rates depend on the costs that banks themselves incur when borrowing funds. While banks do avail loans from the RBI,
these loans account for only a small percentage of their borrowings. “A bank’s cost of funds depends on a number of factors other than repo rates, as a result of their diverse borrowing mix,” says Miren Lodha, director, Crisil Research. “On average, deposits, which include current accounts and savings accounts, constitute over 80 per cent of bank borrowing.” In other words, the RBI’s reduction of the repo rate has no effect on the vast majority of bank borrowing, since the bulk of banks’ funds come from deposits. The ‘cost’ of these deposits is the interest rates that banks offer depositors—and banks cannot reduce these rates without seeing a corresponding decrease in deposit rates. “In 2018-19, total credit of scheduled commercial banks grew by 12.2 per cent, while deposits grew by 9.9 per cent. In order to keep deposit growth high, banks are unlikely to cut deposit rates by a significant amount. However, once deposit growth outpaces credit growth, the transmission of rate cuts will be higher,” says Lodha.
Since the bulk of bank funds come from deposits, maintaining a high deposit growth rate is crucial for banks to remain well funded—and since depositors are shifting to instruments such as mutual funds and equities in expectation of better returns, banks are forced to maintain high interest rates for their deposit accounts to remain competitive.
Another major factor impacting banks is bad loans, or non-performing assets (NPAs). The scale of the NPA problem has put significant strain on bank margins. Since banks must maintain higher cash balances—higher provisioning—to offset potential losses from NPAs, this reduces the total funds available for loans. Further, this also becomes a reason for banks to not reduce lending rates—they must make more money off the fewer available funds, which means high interest rates.
➘ SMALL SAVINGS
Banks also face stiff competition from small
THOUGH THE RBI HAS CUT ITS BENCHMARK RATE SEVERAL TIMES THIS YEAR, POTENTIAL BORROWERS WHO HAVE BEEN WAITING FOR LOWER INTEREST RATES ON LOANS MAY HAVE TO WAIT LONGER
saving schemes like Public Provident fund deposits, Kisan Vikas Patra deposits and the National Savings Certificate, the last of which is among consumers’ most preferred saving instruments. As interest rates on such instruments increase (as well as for term deposits, offered by post offices), banks have to raise deposit rates to remain competitive. Between September 2018 and March 2019, the interest rate on one-year term deposits under post office savings schemes increased from 6.6 per cent to 7 per cent. As a result, bank deposit rates had to follow suit—in May this year, State Bank of India also raised its deposit rates to 7 per cent.
These small saving scheme rates have forced deposit rates to remain high, which means elevated fund costs for banks. And since small saving schemes are a significant source of financing for the government, it has also been slow to reduce interest rates. These marketlinked rates are reviewed on a quarterly basis—in June this year the government reduced interest rates for small saving schemes by 0.1 per cent for the July-September 2019 quarter.
This may ease some of the pressure on banks. However, more rate cuts will be required—if one compares interest rates offered for long-term deposits under small saving schemes and by banks, the difference is still significant. A five-year term deposit with post offices earns 7.7 per cent, while a similar investment with SBI earns 6.6 per cent. Whenever this differential decreases, it will give banks the scope to reduce the deposit rates they offer consumers, and therefore also the interest rates they charge borrowers. “We expect the rate on small savings schemes to be cut further in the third quarter of this financial year, which, when coupled with the declining interest rate environment, should translate into lower deposit costs for banks, and therefore, more rate cuts by banks going forward,” says Supreeta Nijjar, vice president and sector head for financial sector ratings at ICRA.
➘ WHAT ABOUT EXISTING LOANS?
However, even if there is a reduction in lending rates, the benefit will be passed on to new borrowers first. Existing borrowers generally receive such benefits later. Most banks follow marginal cost of funds-based lending rates (MCLR). The RBI has asked banks to switch to external benchmarking of lending rates for better transmission of changes in benchmark rates—however, it is yet to release its final guidelines on this matter. Under MCLR, the interest rate on a loan changes based on the reset tenure, which is generally one year in the case of home loans. In effect, even if there is a reduction in the MCLR of the bank, existing borrowers will only see their interest rates decrease a year after their last reset date. Therefore, in the event of a rate change, existing home loan borrowers might be best served by opting for a loan transfer (if they can find a lender offering a lower rate of interest). “If transferring the existing home loan to another lender leads to a substantial reduction in the interest cost, then borrowers should first approach their current lenders for a reduction in their interest rate. If their lenders refuse, only then should borrowers transfer their existing loans to the new lender,” says Ratan Chaudhary, head of home loans at Paisabazaar.com. However, borrowers should also note that processing charges are a major factor. Before opting for a transfer, borrowers should first perform a costbenefit analysis to calculate how much they would actually save by switching to a new lender. ■
BEFORE CHOOSING TO TRANSFER THEIR HOME LOANS TO A NEW LENDER, BORROWERS SHOULD FIRST PERFORM A COST-BENEFIT ANALYSIS TO CALCULATE HOW MUCH THEY WOULD ACTUALLY SAVE