Who Benefits When the RBI Cut Rates

The Reserve Bank of India (RBI), had for the fourth time in 2019, reduced the repo rate. Earlier, on 6 June 2019, it had decreased the repo rate by 25 basis points (bps) bringing it down from 6.00% to 5.75%. This has a direct bearing on you, the customer, who takes loans from banks. Read on to find how this impacts you

On 7 August 2019, RBI brought it further down by another 35 bps. Due to this, the current repo rate is 5.40%. This has a direct bearing on you, the customer, who takes loans from banks. Read on to find how this impacts you.

Note - One basis point or bps equals to one-hundredth of a percentage.

Repo rate, the bank, and the customer

Repo rate is the interest at which RBI lends money to commercial banks in the country. Every time this rate reduces, it means that other banks can now borrow money from RBI at a much lower interest rate.

The commercial banks usually pass this benefit on to their customers by reducing the interest rates on the loans they offer. Therefore, every time there is a cut in the repo rate, there usually is a decline in the interest rates on loans offered by various banks.

How does this help you? It reduces your interest rates which means you pay a lesser amount of interest. This brings down the overall cost of your loan.

Personal loans, car loans, home loans, etc. are expected to get cheaper due to the recent reduction in the repo rate. However, this will come into effect only if banks decide to pass on the benefit to their customers.

How it impacts the industrial sector

Apart from benefitting general borrowers, this also is a huge boost to the industrial sector. The reduction in the repo rate means that industries may be able to get loans at cheaper interest rates from lenders. This is likely to result in commodities becoming cheaper due to lower interest costs, ultimately benefitting you, the end consumer, again.

That said, it remains to been seen how soon banks will implement rate cuts on the loans they offer.

Pass through of policy rate cuts

When a reduction in policy rates occurs, financial circles are usually buzzing with questions on when the rate cut will translate into actual reductions in bank loan interest rates.

The International Monetary Fund (IMF) conducted a study on the interest rate transmission in the country, in which, the following were deduced:

  • There is a slow pass-through of policy rate changes to the interest rates offered by banks.
  • Banks tend to decrease the deposit rates during rate cuts but do not reduce lending rates right away. However, when the policy rate increases, lending rates rise quickly, but deposit rates don’t change that fast.
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What Makes The Monetary Transmission Slow?

Money is a bank’s raw material, absolutely vital to its day-to-day operations. In any industry, whenever an important supplier reduces the prices of the raw materials it supplies, it triggers price cuts downstream. This refers to deposit rates in the case of banks.?

Now, whether a bank passes on the benefit of the lower interest rate to its customers or not depends on the level of competition in the market.

If any particular bank holds the monopoly power in the industry, it is not under any pressure to pass on the lower-cost benefits to its consumers right away. This means that the transmission of benefits arising out of RNI rate cuts may end up taking a long time.

Let’s take a look at some of the reasons for this:

  • Banks also find it difficult to reduce lending rates in the short term after a policy rate cut due to the fixed rate of interest on deposit contracts. Also, there is competition from small savings instruments, which makes it difficult to reduce the rates that depositors are offered.
  • Another issue that impedes monetary transmission is the pressure on banks to enhance equity financing and reduce risky debt financing. This problem is particularly relevant to the current financial landscape in India.
  • The new focus stems from the financial crisis in the U.S. that drew attention to the dangers of debt financing and excessive dependence on it. At the time of a policy rate cut, reducing the deposit rates (and not the loan rates) is a convenient way for banks to increase their interest margins. This also paves way for increased profits, which are in fact, a form of equity that improves their balance sheets.
  • The level of equity needed by banks is determined by the amount of loans they have. When they don’t immediately cut loan rates, banks stand a chance to lose some customers. The current financial environment accepts that loss because it retards the growth of loans and the subsequent need to improve equity.
  • Therefore, the speed at which rate cuts pass through will be slow if the banks are facing pressure from regulators to improve their capital buffer.
  • The government ownership of banks also acts as an impediment to transmission. The ability of a government bank to increase equity depends on its disinvestment programme and the decision to infuse equity. Since banks do not control this decision, they increase the interest margin and slow loan growth. Hence, the monetary transmission, in this case, is dependent on the government’s decision to shore up the balance sheets of banks.
  • Some commercial banks have indicated that a CRR cut is required to bring about a traction in monetary transmission. A meaningful cut in CRR, apart from introducing additional liquidity into the system, frees resources to lend and helps banks in passing on rate cuts without adversely impacting their net interest margin.

While this is a great tool to control inflation, RBI often uses this monetary policy method after factoring the condition of the Indian economy and inflation levels to control the market inflation and manage the liquidity of the economy. However, this process might not prove to be effective if the banks are not ready to pass on the rate cut to the customers.

The bottom line is that apart from the lag in monetary transmission, banks are unlikely to match RBI’s rate cuts. However, additional rate cuts and liquidity support measures are needed to encourage banks to lower rates in the future.

When RBI cuts rates

  • HDFC Bank may increase loan rates after the September 7 review

    ICICI Bank, one of the largest private banks in the country and State Bank of India recently raised raised the marginal cost of funds based lending rates effective September 1. It is expected that HDFC will be doing the same by revising the marginal cost of funds based lending rate when the bank takes it for review on September 7. State Bank of India increased its lending rate 0.20% across all tenors effective from September 1. It is expected that all the other banks will likely make changes to their marginal cost of funds based lending rates as well in the coming weeks. With the new changes, the marginal cost of funds based lending rates now ranges between 8.1 percent and 8.65 percent. The marginal cost of funds based lending rates of HDFC currently range between 8.40 percent and 8.70 percent.

    4 September 2018

  • Rs.136 crore Nabard warehouse fund sanctioned to Karnataka Government

    The Karnataka government has received a loan assistance of Rs.136.57 crore from the National Bank for Agriculture and Rural Developments(Nabard) as Warehouse Infrastructure Fund. The assistance from Nabard is to build 163 covered auction platforms at close to 135 Agricultural Produce Market Committees(APMCs) and 103 warehouses in 28 districts. Nabard has now sanctioned around Rs.1,271.62 crore under the Warehouse Infrastructure Fund for construction of 269 market yards and 340 warehouses across the 28 districts in the State.

    7 June 2018

  • India in the top spot among world’s fastest growing major economies

    According to a Reuters poll of economists, this year, India will likely be on the top spot amongst the world's fastest-growing economies. However, the increasing trade tensions between China and the US may put a strain on that growth. As per the latest poll, India's economy will grow 7.4% in this fiscal year. In the next fiscal, the economic growth is predicted to average 7.5%.

    Although the country's retail inflation has reduced this year, it was more than the RBI's 4% medium-term target. Government's increased spending before the national elections will likely be inflationary. Inflation is predicted to average 4.7% at the end of this fiscal year and 4.9% in the following year. India Met has forecast a normal monsoon in 2018 which is beneficial to the agricultural sector as it accounts for 15% of the country's $2 trillion economy. A normal monsoon may prompt a rate cut by the RBI in August.

    19 April 2018

  • RBI approves the acquisition of IL&FS Securities Services by Induslnd Bank

    The Reserve Bank of India (RBI) has given a nod to private sector banking firm Induslnd Bank to acquire the securities services division of Infrastructure Leasing and Financial Services (IL&FS). The size of the deal is, however, yet to be confirmed. The talks for this acquisition had been initiated in March 2017 and the proposed acquisition was of Indusind Bank having a 100% stake in IL&FS Securities Services Ltd. (ISSL).

    On the Bombay Stock Exchange (BSE), Induslnd Bank was trading at Rs.1796.30 exhibiting a low of 1.84%. Recently, Induslnd Bank had run tests for providing banking services to customers through Whatsapp and with the project, the private lender is looking at making communication with the customer two-way.

    9 April 2018

  • According to RBI, women’s share in banking rose to 19.3% in 2017

    According to the Reserve Bank of India (RBI), the percentage of women participating in banking rose to 19.3% in 2017 from 8.8% in 2001. About one-fifth of customers borrowing from banks were women and 32% of women had opened new accounts in 2017 compared to 22% in 2001. Even Small Finance Banks had had an increase in women customers due to their microfinance model, but this data was not included in the study conducted by the RBI.

    28 March 2018

  • RBI has revised reference rate for rupee at Rs.64.9941

    On 6 March, the Reserve Bank of India had announced the revised reference rate for rupee at Rs.64.9941 from Rs.65.0530. Likewise, RBI fixed the reference rate for Euro at Rs.80.2092 from Rs.80.0347. As for the British Pounds, the reference rate is at Rs.89.9063 from 6 March 2018 and Rs.61.20 for 100 yen (earlier it was Rs.61.64). The SDR-Rupee rate will be based on the new reference rate.

    14 March 2018

  • HDFC Bank hikes its MCLR by 10-15 bps

    On 7 March, HDFC Bank increased its marginal cost of funds-based lending rates by 10-15 bps which is the second raise in MCLR by the bank in a matter of a few months. The current 1-year MCLR is 8.3%. The overnight MCLR is 7.95%, 1-month MCLR is 7.95a5, 3-month MCLR is 8%, 6-month MCLR is 8.15%, and the 2-year MCLR is 8.45%, respectively. The 3-year MCLR of HDFC Bank loans was raised by 10 basis points to 8.6%.

    Punjab National Bank, ICICI Bank, and State Bank of India raised their MCLR earlier this month which is the first rate hike since the implementation of MCLR in April 2016. According to analysts, banks will have better pricing power as liquidity has tightened and large borrowers have transitioned to MCLR framework.

    9 March 2018

  • RBI scrutinises the process of allowing companies to raise money overseas

    The Reserve Bank of India (RBI) is scrutinising the hedging practices of companies and vetting borrowers carefully in order to be prepared for any fallout in the financial market owing to an increase in the US interest rates. The central bank is concerned about the borrowers' inability to repay debt in the case of any increase in rupee volatility. The approval process for offshore debt sales has slowed down in the recent weeks. Companies are required to get loan registration numbers (LRNs) for raising debt overseas as per the guidelines of the country's external commercial borrowing. RBI has been slow in issuing LRNs to some borrowers.

    After Indian companies raised $15.6 billion the previous month, the overseas bond sales have slowed down this month. Suzlon Energy Ltd, Indian Railway Finance Corp Ltd, Reliance Industries Ltd, Videsh Ltd, ONGC, and Bharti Airtel Ltd are some of the big borrowers who may be affected by any new restrictions on the offshore borrowing rules.

    21 February 2018

  • EPFO likely to raise the cap on investment in stocks by high-income employees

    The government set a minimum limit for equity investment to 5% for EPFO in April 2015. EPFO had an equity exposure of Rs.44,000 crore as of January 2018. The interest rate remains unchanged at 8.65%. Subscribers of the National Pension Scheme can invest up to 50% of their savings in equities. The Employees Provident Fund Organisation (EPFO) is proposing a similar investment limit to employees with higher salaries. The low-income employees will continue with the 15% cap while the high-income employees can invest 25% of their PF contribution in stocks.

    20 February 2018

  • Top banks regained hold in the banking space after RBI holds the repo rate

    Stocks of Indian banks which were under pressure before the repo rate review, regained hold in the banking space after the RBI left the existing repo rate unchanged. SBI, HDFC Bank and ICICI Bank are among the top banks which lead the gains in the Sensex on 7 December 2017. The stocks of ICICI bank and HDFC Bank resulted in the maximum upsurge of the Sensex among all banking components. Out of the total 205 points gain, around 45 points are added to the index by the stocks of these two banks.

    One day before this upcharge, The RBI Monetary Policy Committee of 6 members led by Urijit Patel kept the repo and the reverse repo rate on hold without making any revisions in the existing 6% and 5.75% rate. While the IndusInd Bank and the Kotak Mahindra Bank lost up to 0.02% in the Sensex after the hold, the ICICI Bank, Yes Bank, Bank of Baroda, PNB, Federal Bank, SBI, IDFC Bank, Axis Bank, Canara Bank and HDFC Bank leaded the gains with up to 1.34%, 1.29%, 1.18%, 1.1%, 0.93%, 0.93%, 0.56%, 0.4%, 0.36% and 0.36% respectively.

    12 December 2017

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