RBI Governor Shaktikanta Das has given enough hints that linking of interest rates to an external benchmark is likely to happen. Das’ remarks come weeks after state-run lenders volunteered to link interest rates to RBI’s repo rate — a marked turn from their traditional Marginal Cost of funds-based Lending Rate (MCLR).
“Linking of new loans to an external benchmark like the central bank’s repo rate will be formalised as an economic impetus and is required not just from monetary policy assistance but also through transmission of rates,” Das said at an event on Monday.
The Reserve Bank of India (RBI) chief first deferred the rollout of external benchmark rate with effect from April, but now he appears convinced that transparency in passing policy rate cut benefits is paramount. For, of the 75 bps repo rate cut till July, banks barely managed to transmit 29 bps to customers. “It should be, and can be better,” he said adding, “Our expectation is that they (banks) should move faster.”
As a result of high real interest rates, credit demand including industrial credit and retail credit, remained subdued for quite sometime. Worryingly, retail credit is showing signs of deceleration as consumers delay spending as demand is witnessing a slowdown.
“I think the time has now come to formalise the linking of the lending rates on new loans to external benchmarks like the repo rate. We are monitoring the developments in this regard and whatever steps are required in the coming weeks, will be taken by RBI,” he said adding, “We have kept the external benchmark in abeyance because we wanted to see how the market evolves. It’s a positive trend that the banks have responded but this process needs to be faster.”
Meanwhile, analysts believe such a move could impact banks’ margins.
“There could be some impact even on the SBI (State Bank of India) as its government deposits could see volatile movement. Rural and semi-urban markets have seen a rise in savings account share irrespective of interest rates. The market condition is probably forcing banks to maintain a status quo on product offerings,” Kotak Institutional Securities noted.
Besides, savings accounts, cash credit loans (greater than Rs 1 lakh) too would be 225 bps in excess of the repo rate. It means, interest rate of 8 per cent against the prevailing MCLR of 8.55 per cent. But going forward, the spread might be higher based on the overall risk assessment by the bank.
Kotak, though said the current impact of the move would be negligible, and could even be beneficial in the long-run. It, however, added that its medium to long-term impact is contingent on internal and external variables.“Internal variables would be customer behaviour during different interest rate regimes and external variables being competitor reaction for such products and importantly, the ability to shift deposits and loans to competing lenders,”Kotak Securities noted.
According to the brokerage, a move towards market benchmark, even if it means to 25 per cent of borrowers, is still a painful transition as it would be the third change in ten years (Prime Lending Rate/base rate/MCLR).
There has been a severe push back by banks until recently to delay external benchmarking for one simple reason. Since deposits are not linked to an external rate, linking lending rates alone will create a mismatch. Banks are unable to link deposits to external rates as more than 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.