Banks gain, but borrowers may have to wait

Banks have reason to cheer after the monetary policy announced by the Reserve Bank of India, as their cost of funds is likely to dip immediately. But borrowers may not have a reason to party yet, as bankers are not keen to reduce lending rates immediately. Banks continue to grapple with low-deposit mobilisation and the possibility of further hikes in long-term rates, based on inflation trends.

Relief for banks

The RBI’s monetary policy announcement of Tuesday met expectations on key aspects -- reducing the marginal standing facility (MSF) rate by 25 basis points and increasing the repo rate by 25 basis points. Thus, the repo-MSF (7.75-8.75 per cent) differential has now come down to the earlier 100 basis points, narrowing from 300 basis points in July. But one measure that brings unexpected relief to banks is their ability to now borrow more from the new term repo window. They can now source 0.5 per cent of net demand and time liabilities from this window, compared to 0.25 per cent earlier.

Banks have seen a sharp spike in their borrowing costs in recent months, with MSF rates rising and the repo borrowings capped at Rs 40,000 crore. Banks borrowed as much as 60 per cent of their requirements from the more expensive MSF window. But in the beginning of October, RBI opened a new window for banks to source funds - the 7- and 14-day term repos. This has been a marginally cheaper option with cut-off rates at 8.8 per cent. By borrowing close to Rs 20,000 crore from this window, banks were able to minimise recourse to MSF and reduce their average costs by 10-15 basis points.

By doubling the sums that banks can source from term repos to Rs 40,000 crore, the RBI has handed banks a savings of another 10-15 basis points on costs. Overall, cost of funds has come down by 80 basis points from August. This will indeed lead to incremental savings for banks.

But it will also pose challenges for banks on asset (loan)-liability (deposit) mismatches. “Banks will now need to re-align their asset-liability management towards short-term borrowings than overnight borrowings. Hence, banks may have to tweak short-term deposit rates more frequently. For now we do not expect a significant impact on deposit rates,” says Ajay Marwaha, Head–Trading, Treasury, HDFC Bank.

Lower deposit rates?

But what is good for banks may not be great for depositors, who have enjoyed a prolonged period of high interest rates. RBI’s actions from July had resulted in banks hiking deposit rates by 50-75 basis points across tenures in the last couple of months. With the recent rollback, banks may re-evaluate deposit rates.

Wait for borrowers

As for borrowers, they may have to wait a while to see their equated monthly instalments come down. Banks are wary of sharply trimming lending rates on three counts.

One, the cost of borrowing for banks is still 75-100 basis points higher compared to three months ago. This will remain high as long as bank borrowings from the repo window are capped. As long as the cap exists, term repo rates will be closer to MSF rates and hence, overall cost of borrowings will continue to remain above 7.75 per cent.

Two, by flagging concerns on inflation and the possibility of a further repo rate hike, RBI had indicated that long-term interest still have an upward bias. The yield on the 10-year G-sec continues to hover at 8.5-8.7 per cent.

Three, the rate outlook will also depend on how the rupee-dollar equation plays out. The RBI has managed to contain the rupee volatility partly by keeping oil marketing companies out of the currency market. But it remains to be seen how the rupee behaves once this arrangement comes to a close. This, in turn, will decide both interest rates and liquidity easing measures by the RBI.