Why private banks’ average lending rate on new loans has gone up

Even as the market is keenly awaiting the RBI’s upcoming policy and debating the possibility of further rate cuts, data suggest that some banks may have in fact been increasing lending rates. According to the monthly data put out by the RBI, the weighted average lending rate on fresh loans for private banks has gone up by 38 bps in July to 9.12 per cent from 8.74 per cent in June. The weighted average lending rate on outstanding loans, too, inched up for private banks by 5 bps between June and July.

The RBI had last cut its key policy repo rate in May by 40 bps to 4 per cent and since then held rates due to rise in inflation. While that may explain banks’ reluctance to cut lending rates further, an increase in loan rates is intriguing.

Banks had introduced repo-linked loans from October last year (on the RBI’s directive). Under this, banks are forced to re-price their loans with a change in repo rate. An increase in lending rate on fresh loans (when there is no change in repo rate) could imply that some private banks are charging a higher risk premium on certain loans, given the weakening credit environment. Higher provisioning necessitated by Covid, lower other income, and relatively higher cost of funds (given growth challenges in deposits for few banks) may have also nudged some banks to increase loan pricing.

The weighted average lending rate of PSBs on fresh loans have been steadily falling since January. It stood at 8.16 per cent as of July, 2 bps lower than in June.

Varied rate actions by banks

After the 135 bps reduction in repo rate in 2019, the RBI slashed policy repo rate by 115 bps so far this year.

To address the issue of weak transmission, RBI mandated banks to introduce repo-linked loans from October last year. The intent was to ensure that repo rate cuts get reflected on lending rates much faster (banks have to reset their repo-based benchmark rates at least once in three months). Hence, banks have reduced their repo-linked benchmarks sharply over the past few months on the back of the RBI’s cut in repo rate.

Then how can lending rates increase for few banks? The final lending rate is a function of the benchmark rate and the spread that banks charge over it. Banks are free to decide the spread over the external benchmark, depending on their assessment of the borrowers’ credit risk premium. There are also other components of spread, including operating cost, but they can be altered once in three years.

Hence, the final lending rate can go up or down even if there is no change in benchmark rate, depending on the spread that banks charge.

Given the worsening business environment and higher credit risk, it is possible that a few private banks are charging higher spread on certain loans. This could be one reason for the lending rates to increase. Aside from factoring in borrower’s risk, some banks may also want to offset the impact of weak credit growth, higher provisioning and lower other income. A higher spread can help protect margins.

Besides, with depositors preferring to park money in PSBs after the YES Bank crisis, some private banks have seen deposit flows fall or moderate, forcing them to keep deposit rates high. PSBs’ 3-5 year deposits currently offer 5-5.25 per cent, while for private banks it ranges between 5.5-6.75 per cent. Higher cost of funds could have also led some private banks to increase pricing of certain loans.

Finally, the RBI’s weighted average lending rate is a function of lending rate and volume of loans. Higher lending activity by private banks (with higher loan rates) could also have bumped up the overall lending rates.