Banks reaping benefits of rate cuts, not customers

Mumbai: Ever wondered why the equated monthly instalment (EMI) on your home loan has marginally fallen even though the Reserve Bank of India (RBI) has lowered its Repo rate by 125 basis points since January this year? Repo rate is the rate at which the central bank lends money to commercial banks in the event of any shortfall in funds. One basis point is one hundredth of a percentage point.

In the recent policy cycle, RBI has cut policy rates since January by a cumulative 125 basis points but the country’s largest lender SBI has cut the base rate by 70 basis points. Base rate is the rate below which a bank cannot lend.

A study of the last 10 years conducted by India Ratings shows that the policy cycle is being used by banks to their own advantage. In most cases, when policy rates have reduced, deposit rates have come down faster and the quantum has also been higher compared with lending rates. The same was also true when policy rates were hiked, where lending rates went up and the quantum was also higher compared to deposit rates.

Banks have cut one-year deposit rates by an average 130 basis points and lending rate by only 50 basis points, which includes the base rate cuts in the last one week.

A few days back the RBI cut its repo rate for the third time by 50 basis points. In response to it, the country largest lender State Bank of India (SBI) cut its base rate by 40 basis points to 9.3 per cent but cut the home loan rates by 20 basis points for new borrowers.

Existing customers will however see a reduction of 40 basis points without any switching charges. But the point is that SBI has so far reduced its base rate by only 70 basis points in response to 125 basis points cut by RBI in Repo rate.

“Repo rate cut affects only a small portion of the deposits. Deposits are large in tune with small savings scheme. We cannot cut deposits immediately as they compete with small savings schemes such as national savings certificate, PPF. Once the deposits get re-priced the benefits of lower cost of funds are passed to the borrowers,” said J Lakshmi, chief general manager (real estate & housing business unit), SBI.

Similarly, the country’s largest private sector lender ICICI Bank announced a base rate cut by 35 basis points to 9.35 per cent but has increased the spread or mark-up over base rate paid by a borrower by 0.10 per cent for both women and salaried borrowers for floating rates. Accordingly, women borrowers opting for loans under Rs 5 crore will have to pay an interest of 9.60 per cent against the earlier 9.85 per cent, and salaried borrowers will have to pay 9.65 per cent against earlier 9.90 per cent, its website said. Most other banks have cut base rate by 25-30 basis points.

“Interest rate cuts and hikes have been utilised by banks to absorb the upside and pass on the downside to customers said a study by India Ratings and Research (Ind-Ra),” said Sunil Sinha, director public finance and principal economist at India Ratings.

“In certain cases while base rates have been reduced by banks, spreads have been increased, netting out part of the benefit to the consumers. Some banks have cut lending rates, to a larger extent for new customers and not as much for their existing customers, while charging existing customers if they wish to switch to the lower rates,” added Sinha.

In the last 18 months, three-month commercial paper and certificate of deposit rates have fallen by 150bp. Thus transmission of policy rates has been more through market rates and banks deposit rates in the last one-year. In certain cases while base rates have been reduced by banks, spreads have been increased, netting out part of the benefit to the consumers.

Raghuram Rajan, governor, RBI in the fourth bi-monthly monetary policy statement last week highlighted, “Markets have transmitted the Reserve Bank’s past policy actions via commercial paper and corporate bonds, but banks have done so only to a limited extent.”

Sinha said that banks are holding the transmission in rates back and they have been re-pricing with a lag only the unfavourable movements in rates.

Bankers have been reluctant to transmit the entire policy rate cut to borrowers and have sought a reduction in the interest rates on small savings schemes on fears of flight of cash from bank deposits to such schemes.

This has been one of the major impediments for the lending rates being higher believe bankers, however transmission on the deposit side has been fully passed through and in most cases banks deposit rates are lower than rates offered by most small saving deposit schemes like Public provident fund (PPF), national savings certificate (NSC) etc.

According to India Ratings, in the last decade small saving deposit schemes have offered rates between 8-9.3 per cent unrelated to the up-cycle or down-cycle in policy rates. These rates are also politically sensitive since elders, farmers and low-income groups make a bulk of this saving. In fact in 2009 when Repo rates were at a low of 4.75 per cent, PPF and NSC both continued to offer 8 per cent return and in 2012 when the Repo rate moved up to 8.5 per cent, PPF offered 8.8 per cent and NSC offered 8.6 per cent return.

The funds raised under the small saving schemes are significantly lower than the amount banks raise from term deposits. However in times of rate differentials, retail investors shift from investing in term deposits to small savings schemes to take advantage of the higher rates. “As evident from the 2.7 times y-o-y increase in the amount of securities issued against small savings schemes in FY15 (Rs 3.33billion), and the 12.5 per cent dip in the amount banks raised from term deposits (Rs 7.9 trillion),” said the study.

Ind-Ra strongly believes there is a clear aberration in monetary transmission, which needs to be corrected so that the lower interest rates get passed on to borrowers. This is particularly imperative in the current scenario, to support demand recovery through capex and discretionary spending.