‘Linking rates to ex-benchmark is credit negative’: Moody’s Investors Service

It’s also unclear if banks will be able to mitigate the risk by linking interest rates on CASA deposits to an external benchmark.
Moody's (File Photo | Reuters)
Moody's (File Photo | Reuters)

HYDERABAD: The Reserve Bank of India’s mandate asking banks to link select floating loan rates to an external benchmark from October 1 is credit negative for domestic banks, said Moody’s Investors Service.

According to the global ratings firm, the move limits banks’ flexibility in managing interest rate risk. It added that under the new regime, while the floating-rate loan book will get re-priced, only the non-CASA (current account savings accounts) deposits will see a re-pricing on deposits.

“This will cause volatility to bank’s net interest margins (NIMs), with NIMs rising when interest rates increase and declining when interest rates fall. This volatility in NIMs will translate into volatility in the overall profitability of banks,” Moody’s explained.

It’s also unclear if banks will be able to mitigate the risk by linking interest rates on CASA deposits to an external benchmark. A significant portion of bank deposits comprise CASA, on which interest rates are generally low yet stable. Consequently, banks don’t prefer to lower rates further as it could lead to flight of customers.

“For instance, the State Bank of India (Baa2 stable, ba1) has linked its savings deposit rate to the repo rate, but subject to the savings deposit rate not falling below 3 per cent,” Moody’s observed. It also pointed out the absence of a single benchmark that can consistently and accurately capture the movement of interest rates in the economy will also cause volatility to banks’ NIMs — key parameter of profitability.

“Therefore, benchmark selection will be difficult and will cause inherent volatility to banks’ NIMs,” it said.

According to Moody’s, since banks’ funding requirements are dynamic, the new rules will impede the ability of banks to reflect such changes in funding costs of their lending rates as these rates will be linked to an external benchmark.

“The new rules will be applicable only to new personal, retail and micro, small and medium enterprises (MSME) loans. Therefore, the near-term impact will be mitigated as new loans will be a relatively small portion of banks’ loan books to begin with. However, over time, most of the retail and MSME loans will transition to the new mechanism,” it said.

In a bid to improve transmission of rates, the RBI last week noted that the current MCLR framework wasn’t satisfactory and hence mandated lenders to move to an external benchmark.

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