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Bankers explain why their rates don’t fall as fast as RBI’s

Chillicious Team

Even as the broader trajectory of banks’ lending rates is headed lower, thanks to the Reserve Bank of India’s decision to slash the benchmark repo rate by 50 basis points, or 0.5 percent, the country’s top bankers remain hesitant to put a timeline to when rates will fall, only saying their asset-liability committees (ALCOs) will meet soon to decide.

The hot-button issue of transmission of interest rate cuts is a much discussed issue in financial circles and India Inc too has been clamouring for banks to cut interest rates faster.

For instance, ever since Raghuram Rajan-led RBI changed its monetary policy stance earlier this year, and slashed its repo rate by a total 125 basis points in four moves (from a peak of 8 percent to 6.75 percent), in the same period, SBI has slashed its base rate by 60 bps (from 10 percent to 9.4 percent).

The repo rate is the rate at which the central bank lends to banks while the base rate is the minimum rate at which a bank can lend to customers.

The spread between the repo rate and banks’ base rates is averaging nearly 3 percent, unusually high compared seen in light of the past.

At a press conference, a bevy of top bankers weighed on the issue, explaining why “transmission” of interest rate cuts has been slow of late.

“Interest rates get transmitted with a lag,” said ICICI Bank chief Chanda Kochhar, explaining that a key reason for the lag is marginal cost of funds. “But they will transmitted nonetheless”.

The concept of marginal cost of funds is simple: banks raise funds through a mix of sources, such as low-cost savings and current account deposits, as well as through higher cost time deposits (FDs etc) and market borrowings. The difference between the blended cost of funds and the rates at which they lend contribute to interest income.

But when the central bank slashes the repo rate, banks have to wait for it to reflect in market rates (such as in money markets) and have to slash their deposit rates first in order to bring their cost of marginal funds down.

The issue of how banks calculate their cost of funds is also been a subject of some discussion. “If you look at the average cost of funds, the denominator is very large and incremental lower cost funds will not make it fall substantially,” pointed out HDFC Bank chief Aditya Puri.

The RBI has recently proposed guidelines that will make banks give greater weightage to marginal cost of funds, a step it undertook after it thought banks had been slow in order to transmit rate cuts.

The slowdown in the economy further aggravates the problem: with not enough corporates seeking credit, banks have to park part of their funds in investments in lower-yielding governments securities etc.

Further, banks face further pressure to not cut deposit rates as products such as FD compete with high-yielding savings products offered by the government such as PPF, etc.

“You have to take into account impediments [such as the small savings schemes] in the overall financial system,” Kochhar said.

The government has also said it would evaluate the small savings scheme framework in order to remove any impediments to rate cut transmission — but any cut in rates of products such as PPF can be an unpopular move.