RBI in September 2015 in it's fourth bimonthly monetary policy review slashed repo rate by 50 bps while most banks cut their lending rates in the range of 20-40 bps, thereby not passing on the full benefit to the customers. What's holding the banks back?
Shubham Saxena Grad. IIT Dhanbad
It is not exactly that banks don't want to cut their base rates, they really can't cut the base rates anymore. Let's see what is restraining them. RBI in September 2015 cut down repo rate by 50 bps while most banks cut their lending rates in the range of 20-40 bps, thereby not passing on the full benefit to the customers. RBI and government are alleging and compelling banks to pass on the full benefit of rate cut to the customers. The main reason cited for why banks are very reluctant to reduce lending rates is the high interest rates offered by the government on small saving schemes. These high rates purportedly makes it difficult for banks to reduce their deposit rates and consequently lending rates.
At present, small savings rates are linked to yields on government bonds of similar maturity. The rates are revised annually. Government pays a premium of 25-50 bps over and above average G-Sec yield. In falling interest rate regime, which we are currently witnessing, government may prefer to shield investors in small saving schemes from a volatile slide in interest by continuing linking the interest rates on schemes to G-Sec yields rather than repo rates or bank deposits. In falling interest rate cycle, small savings schemes become unattractive if they are linked to repo rate or bank deposit.
Just have a quick look at the interest rates provided on various small saving schemes like
Post Office MIS: ~8.4% @5yr
National Saving Certificate: 8.5% @5yr
Post Office TDS: 8.1%-8.5% @1,2,3,5 yr
Post Office Saving Account: ~4% (interest rate is tax free)
Senior Citizen Saving Scheme: ~9.2% @5yr.
Further in most of the schemes the interest is tax free, no TDS. While currently, most banks in India are providing interest rate on FD below 8% and that is taxable too.
It is obvious that if banks decrease their deposit rates, people will more frequently start mobilizing their funds into such schemes. This makes it very much difficult for banks to lower their base rates as it would badly effect their deposits and margin. The result is that banks are receiving less money in deposits and they don't want to lower their balanced interest margin between borrowing and lending.
Further, Indian government has floated ambitious programs like Make In India, smart cities, digital India in recent year. These would require over $400 billion (₹ 26 lakh crores) in next five years and 70% is likely to be debt financed. Going forward, the bulk finance will be catered to commercial banks that will put a considerable strain on balance sheet due to the mismatch between tenures of deposits and loans disbursed as infra and power loans have long gestation period. An increase in stressed loans is expected, however government and central bank, RBI have recently taken several steps to reduce NPA and stressed loans. It must me kept in mind that stressed loans, 10% as of Nov, 2015, has a significant impact on the outlook of the country's economy and banks, given by credit rating agencies. India's current credit outlook is 'stable' by Fitch. The outlook of most of the Indian banks on the IDRs (Issuer Default Ratings) is stable. Downgrade by even a notch would prove painful for the banking sector and subsequently for the economy.
It is not exactly that banks don't want to cut their base rates, they really can't cut the base rates anymore. Let's see what is restraining them. RBI in September 2015 cut down repo rate by 50 bps while most banks cut their lending rates in the range of 20-40 bps, thereby not passing on the full benefit to the customers. RBI and government are alleging and compelling banks to pass on the full benefit of rate cut to the customers. The main reason cited for why banks are very reluctant to reduce lending rates is the high interest rates offered by the government on small saving schemes. These high rates purportedly makes it difficult for banks to reduce their deposit rates and consequently lending rates.
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| September 29, 2015: RBI Governor Raghuram Rajan announcing fourth bimonthly monetary policy review. RBI cut down repo rate by 50 bps from 7.25% to 6.75% in a surprise outcome. |
At present, small savings rates are linked to yields on government bonds of similar maturity. The rates are revised annually. Government pays a premium of 25-50 bps over and above average G-Sec yield. In falling interest rate regime, which we are currently witnessing, government may prefer to shield investors in small saving schemes from a volatile slide in interest by continuing linking the interest rates on schemes to G-Sec yields rather than repo rates or bank deposits. In falling interest rate cycle, small savings schemes become unattractive if they are linked to repo rate or bank deposit.
Just have a quick look at the interest rates provided on various small saving schemes like
Post Office MIS: ~8.4% @5yr
National Saving Certificate: 8.5% @5yr
Post Office TDS: 8.1%-8.5% @1,2,3,5 yr
Post Office Saving Account: ~4% (interest rate is tax free)
Senior Citizen Saving Scheme: ~9.2% @5yr.
Further in most of the schemes the interest is tax free, no TDS. While currently, most banks in India are providing interest rate on FD below 8% and that is taxable too.
It is obvious that if banks decrease their deposit rates, people will more frequently start mobilizing their funds into such schemes. This makes it very much difficult for banks to lower their base rates as it would badly effect their deposits and margin. The result is that banks are receiving less money in deposits and they don't want to lower their balanced interest margin between borrowing and lending.
Further, Indian government has floated ambitious programs like Make In India, smart cities, digital India in recent year. These would require over $400 billion (₹ 26 lakh crores) in next five years and 70% is likely to be debt financed. Going forward, the bulk finance will be catered to commercial banks that will put a considerable strain on balance sheet due to the mismatch between tenures of deposits and loans disbursed as infra and power loans have long gestation period. An increase in stressed loans is expected, however government and central bank, RBI have recently taken several steps to reduce NPA and stressed loans. It must me kept in mind that stressed loans, 10% as of Nov, 2015, has a significant impact on the outlook of the country's economy and banks, given by credit rating agencies. India's current credit outlook is 'stable' by Fitch. The outlook of most of the Indian banks on the IDRs (Issuer Default Ratings) is stable. Downgrade by even a notch would prove painful for the banking sector and subsequently for the economy.
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