While the RBI has maintained status quo on policy interest rates and pressed on better transmission of monetary policy, HDFC Vice-Chairman and CEO Keki Mistry expects banks to reduce rates further, albeit gradually, in the coming months. Speaking to Bloomberg TV India, he warns that the RBI ‘s proposed move to link banks’ base rates to marginal cost of funds may result in adverse impact on consumers when rates start rising.

Reserve Bank of India Governor Raghuram Rajan announced in his monetary policy that the central bank will shortly finalise the methodology to determine the base rate based on the marginal cost of funds. There is a lot of concern among banks on the proposed move to link the revision in repo rate with the marginal cost of funding, as lenders fear that interest incomes are going to be hit. What is your own understanding of it?

My sense is I think the RBI will take into account all these concerns of banks while framing the circular.

Though we are not a bank and so we do not get directly impacted, my perspective is what will happen is if we move to a marginal cost of funding straightaway the funding cost will come down because we are now in a much lower interest rate regime than we were earlier.

As the base rate comes down some benefits will be passed on to the consumers. But the reverse will happen when the rates go up.

Firstly, at some point of time in the next three-four years, the rates that have come down will also go up — rates do not come down forever.

When that happens, the impact on consumers at that point of time will be very sharp.

The second issue which I think the RBI will be probably looking at is when they move into a floating rate or a marginal cost of funding base for determining the base rate, whether the banks will then be tempted to look more at the short-term borrowing rather than the long-term borrowing.

And that may create, over a period of time, a bit of a systemic problem because there will an asset-liability mismatch (ALM).

So how the banks will manage their ALM and at the same time try and keep reducing the cost of funds by borrowing more short-term money is really, I think, the challenge the RBI will face.

The RBI’s entire focus seems to be on rate transmission, to gauge how inflation works and, more significantly, linking small savings rate with the market rates because there has been a problem in transmission. Do you see rates over a period of time coming down?

I think rates will come down over a period of time.

What we need to understand here is that banks do not only have short-term funds, they also have long-term funds.

It means they would have accepted a deposit say a year ago and if that deposit is a two-year deposit then that two-year deposit will be priced in at the rate prevalent at that time a year ago and that rate was higher than the rates today.

Till the deposit runs out we don’t reprice the deposit and the cost of funding of the bank does not reduce.

So it is a gradual reduction that keeps on happening and is a reduction that happens on a month-on-month basis as old liabilities get replaced by new liabilities, which come in at a lower rate.

So it is a gradual process. One will have to wait and see how much reduction each bank will be able to reflect in its cost.

What is the sense you are getting from the credit offtake from the retail side, especially on the individual home buyer side, at this juncture? Are you seeing a discernable pick-up there?

To be honest, we never saw a slowdown.

So even in the three-four years when there was a big slowdown in the economy, there was never a slowdown for the demand for individual housing loans.

Our borrower profile may be very different from the borrower profile of some of the other companies. Our borrower profile is typically middle income customer, someone buying a house because they need the house to stay in, someone buying a primary residence.

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