Some respite for banks, none for borrowers

By keeping rates unchanged and highlighting upside risks to inflation, the RBI has reinforced the near-zero possibility of future rate cuts. Banks are unlikely to tinker much with lending rates, which have already moved lower by a steep 70-90 basis points over the past three months.

Hence, it’s time for borrowers to shop for best deals rightaway. Depositors fortunately can heave a sigh of relief, as sharp cuts in deposit rates are unlikely. New measures announced by the RBI to manage surplus liquidity, should temper cuts in deposit rates.

Much to the relief of banks, the RBI did not hike the cash reserve ratio (CRR) to suck out excess liquidity. Instead, by raising the reverse repo rate (the rate at which banks lend short-term funds to the RBI) by 25 basis points to 6 per cent, the RBI has helped banks earn a tidy interest on their excess funds for a short period. With around ₹4.4-lakh crore of surplus liquidity in the system, banks can earn close to ₹100 crore more a month, due to the hike in reverse repo rate.

For the borrowers SBI, in January, slashed its marginal cost of funds-based lending rate (MCLR) by 90 basis points. Other banks were quick to follow and there was a 70-80 basis point across-the-board reduction in lending rates (for new borrowers). Since the February 2017 policy announcement though, banks have not tinkered with their MCLRs. But some banks have continued to trim deposit rates.

Bank of Baroda, Bank of India, HDFC Bank, Central Bank of India, IDBI, and SBI have reduced deposit rates by 10-25 basis points in certain tenures.

A look at the extent of reduction in deposit rates and MCLR over the last three months, indicates that transmission has mostly happened entirely. This leaves little scope for further cuts. Lending rates could come down in fits and starts, as some banks pass on the leftover benefit of lower cost of funds.

Despite muted expectations, new borrowers have indeed reaped the benefit of lower borrowing costs in recent times. But, old borrowers, until recently, have not had any respite, as banks had kept their erstwhile benchmark lending rate — base rate — unchanged. SBI and HDFC Bank recently reduced their base rates by 15 and 25 basis points, respectively. Still, loans offered to new borrowers under the MCLR are much cheaper. SBI, for instance, offers home loans to new borrowers at a spread (mark-up over the MCLR) of 65 basis points.

With one-year MCLR at 8 per cent, the effective rate is now 8.65 per cent. In case of old borrowers, even after the base rate was cut to 9.1 per cent, the effective loan rate works out to 9.35 per cent (spread of 25 basis points).

What’s in it for banks The Centre’s demonetisation move has left banks flush with deposits. With credit offtake remaining sluggish, banks have been lending excess funds to the RBI through the reverse repo option.

Banks can essentially borrow money for the short term under the liquidity adjustment facility (LAF).

Alternatively, banks can also lend their excess funds to the RBI and earn interest on them through the reverse repo option.

Over the past two months, banks have been lending funds from around ₹1 lakh crore to as high as ₹2 lakh crore under the variable reverse repo window.

Banks will now earn better interest on these funds, lending money for the short-term to the RBI at an attractive rate of 6 per cent.

With rates on short-term deposits cut aggressively, banks can make a good 2-3 per cent spread on such deposits, albeit for a short period.