The Reserve Bank of India (RBI) pulled off a classic stunt getting banks to link loan and deposit rates to an external benchmark without explicitly saying so.
On paper, the linking of rates to an external benchmark like repo rate — proposed by former governor Urjit Patel — has been indefinitely deferred, but the incessant prodding behind-the-scenes by the Central bank appears to have compelled lenders to voluntarily embrace the model, which they have been collectively putting off till now.
Last week, several public sector banks queued up to announce decisions or plan to link loan and deposit rates to repo rate within this month. Banks including Canara Bank, Allahabad Bank, Union Bank, Andhra Bank, Syndicate Bank, Bank of India and Indian Bank are all volunteering to link rates to repo rate instead of the marginal cost of funds based lending rate (MCLR) in order to promote transparency in transmission of policy rates.
With banks opting for repo rate linking, it resolves discussion and debate about the other two benchmarks namely T-Bills and certificate of deposit (CD) rates and which is superior over the other. For instance, Indian Bank said its home and vehicle loans will be linked to the repo rate from August 15. These loans will carry interest that changes with the repo rate and thus facilitate quick transmission of the policy rate and will be effective from August 15, said Padmaja Chunduru, MD, Indian Bank.
Similarly, Bank of India said another dimension of rate transmission process was by way of offering repo linked lending rate to select customer segments, including personal loans. “We are working out the necessary modalities in this regard so as to launch such products during the current month,” it said.
According to Union Bank, it would link vehicle and housing loans to repo rate, while cutting the MCLR by 15 bps, bringing it down by 30 bps since February. “Housing, vehicle and consumer loans will now be offered on the basis of a repo-linked rate. With the change, the housing loans will start from repo plus 2.9 per cent at 8.3 per cent,” said Mrytunjay Mahapatra, CEO and MD, Syndicate Bank, adding the saving bank deposits of over Rs 25 lakh will also be based on repo rate.
Linking of all retail and micro, small and medium enterprises floating loan rates to an external benchmark like repo rate, or treasury bill rate or CD rate was to come into effect from April 1. RBI Governor Shaktikanta Das last week reasoned that it was delayed taking into consideration the banking troubles, exacerbated by the bad loan pile up. “So, administratively, we did not want to mandate it (external benchmarking) at that particular time; we are monitoring the situation and will take whatever steps are required to ensure better transmission. It is better to allow the market forces to play. Wherever the regulatory interventions are required, we will take necessary regulatory measures,” he said.
Despite the delay in rollout, the country’s largest lender SBI in May rolled out a pilot of sorts linking its short-term loans and large savings deposits rates to repo rate and later home loans from July. While banks initially cheered the delay (as it won’t eat into profit margins) the expense was borne by borrowers waiting for transparency in rate transmission even while bearing the interest rate risk.
Until recently, there has been a strong push back by banks to delay the rollout of external benchmark for one simply reason. Since deposits are not linked to an external rate, linking lending rates creates a mismatch. Banks are unable to link deposits to external rates as over 90 per cent of the deposits are on fixed interest rates, of which about 36 per cent comprise term deposits with three-year maturity and above, implying their rates get reset infrequently.
Empirical evidence shows that monetary policy transmits with a lag of 2-3 quarters on output and 3-4 quarters on inflation and the impact persists for 8-12 quarters.
An external benchmark was expected to reduce the time lag, besides ensuring transparency.