Lending rates can move lower despite RBI  inaction

The RBI Governor did not spring any surprises and kept policy rates unchanged. While the market as well as borrowers would have welcomed an unexpected rate cut, much like the one seen in the RBI’s September policy review, the RBI has already prepped the pitch for lower lending rates, even if no meaningful policy rate cuts happen in the near term.

Come April, the new lending rate norms, under which banks will have to price loans with reference to the marginal cost of funds-based lending rate (MCLR), will force banks to cut lending rates more sharply.

The RBI has lowered its key policy repo rate by 125 basis points since last January, but banks have reduced their base rates — to which all lending rates are pegged — by 50-60 basis points. Borrowers can see more of the benefit (policy rate cut) passed on to them under the new norms.

After the RBI slashed its repo rate by whole 50 basis points in the September policy, banks finally started to cut their lending rates. Currently, the base rate for banks ranges from 9.3 per cent to 9.7 per cent.

SBI and HDFC Bank have the lowest base rate of 9.3 per cent, with ICICI Bank close on heels at 9.35 per cent.

After transmitting about half of the RBI’s rate action, there has been little action from banks post-December policy, when the RBI held policy rates. The RBI has been nudging banks to pass on more benefit to borrowers.

More so because deposit rates have moved lower by 1-1.25 per cent since last January. But with banks relying significantly on longer-term deposits and only about 50-60 per cent of their funding getting re-priced, they have argued that the RBI’s 125-basis-point cut in repo rate (at 50 per cent) has been fully transmitted.

The new lending rate norms, however, may force banks to cut lending rates faster and by a larger amount.

The RBI has now asked banks to fix lending rates benchmarked against the MCLR. Under the new method, the latest (at the time of review) rates offered on deposits or borrowings are taken into account.

The RBI has also recognised that the benchmark rate requires an associated tenor and hence, allowed banks to have different MCLRs for different tenors. This allows banks to factor in tenor premium, which arises from loan commitments with longer tenors.

For one, since banks will have to calculate their cost of funds under the marginal cost of funds method, it will ensure that deposit rate increases or decreases immediately reflect on the banks’ cost of funds and hence on lending rates.

Also, since MCLR is a tenor-based benchmark rather than a single rate, this will allow banks to price loans more competitively based on different MCLRs. So, a short-term borrower can gain from banks offering better rates.

While the new norms will bring good tidings for borrowers, rate action will vary from bank to bank. This is because under the new method banks will have to manage their asset-liability mismatches (when loans and deposits do not come up for payment at the same time) to reduce volatility in earnings.

As the ability of banks to manage the mismatches vary, their ability to offer competitive rates, while safeguarding margins, will also differ.

Broadly, private banks that have a higher share of retail loans and low-cost deposits have been in a better position to maintain margins. While they will also have to be nimble-footed in managing their loan-deposit mismatches now, these banks are likely to be first movers in offering competitive rates, under the new system. Among public sector banks, SBI is better placed to compete with private banks.

Borrowers can thus, expect a lot of action on lending rates from hereon, and it does not hinge on the RBI’s policy action alone.