Transmission of rate cuts at less than 50%

Transmission of rate cuts at less than 50%

MUMBAI: Even as the Reserve Bank has been aggressively signaling lower rates to revive the economy since the pandemic induced nation-wide lockdown by making the cost of borrowing cheaper, banks have transmitted less than half of these rate cuts.

Despite the RBI signaling 115 basis point(one bps is 0.01%) reduction of its benchmark repo rate – the rate at which it lends to banks – since March 2020, weighted average lending rates have fallen by 40 bps and 50bps on outstanding and fresh loans respectively between April and November.

Economists attribute this to the structure of deposit rates in Indian banks. The banking system in India relies heavily on retail deposits compared with wholesale or market-based funding mechanisms. On average, term deposits – the costs of which are effectively ‘locked’ for banks – account for more than 40% of banks’ sources of funding.

“Given that a significant share of banks’ costs are not linked directly to benchmark policy rates, this structural feature of India’s financial system is a big reason for the slow transmission of lowered policy rates into lending rates,” said Rahul Bajoria, chief India economist at Barclays India.

“Past experience shows that it takes about 12 to 18 months for full transmission of policy rates depending on the liquidity conditions. So we may see some more reduction in lending rates over the next six months,” he added.

In addition, banks face an asymmetry in interest rate settings between their deposits and loans. While almost all bank deposit accounts are offered at a fixed interest rate, 80% of bank lending is done via floating rate structures, according a recent research by Barclays Capital.

Another trend is that public sector banks have cut lending more than their private sector counterparts. While weighted average lending rates on outstanding loans have dropped 59 bps between April and November’20 for public sector banks compared 48 bps for private sector banks, weighted average lending rates on fresh loans have dropped 68 bps between April and November for public sector banks compared to 36 bps for private sector banks.

“If we look at the deposit data, public sector banks have had a stronger growth in deposits compared to their private sector counter parts which gives them an edge in pricing loans,” said Anil Gupta, Sector Head – Financial Sector Ratings, Icra Ratings. “Also surplus liquidity with public sector banks is higher with public sector banks, which gives them a better leeway to reduce lending rates”.

Nevertheless, loans grew by around 6% year-on-year, until December 2020. But much of the growth has been through government supported schemes like, The Emergency Credit Line Guarantee Scheme (ECLGS) under Atmanirbhar Bharat. Most of the beneficiaries under the scheme are medium and small sized firms, according to Care Ratings.

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