Banks need to pass on RBI rate cuts to move growth to next gear

Post office term deposits currently yield more than bank deposits, with returns for other schemes such as National Savings Certificates and Public Provident Fund being higher than even post office deposits. Photo: Mint

The central bank’s monetary policy review on Tuesday made it clear that there is no room to cut rates further, given the current set of data. The focus clearly moves to the transmission of the 125 basis points (bps) repo rate cut to lending rates, which have come down by less than half. A basis point is 0.01%.

What is holding up transmission? A key reason, which has been hinted at in the monetary policy statement, is the continuing high rates for small savings schemes. Post office term deposits currently yield more than bank deposits (see chart). Returns for other schemes such as National Savings Certificates and Public Provident Fund are higher than even post office deposits.

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It is not a new problem. The Urjit Patel committee on monetary policy framework highlighted this was a recurring problem during the easing phase. “The resultant substitution from bank deposits to small savings eroded the effectiveness of the monetary transmission mechanism, especially the bank lending channel. To some degree, the annual reset for the small savings rates continues to provide them a competitive edge. Therefore, the option of a half-yearly or quarterly reset should be implemented,” it had said in January 2014.

The government had also said it would look to link the rates on these schemes to market rates after the September policy review, when the central bank had front-loaded its cuts by a more than expected 50 bps.

That said, banks have already cut deposit rates ranging from 85 bps to 1 percentage point since January.

“So, in that sense, there is room building up for banks to transmit more, and it is just a matter of time,” Reserve Bank of India (RBI) governor Raghuram Rajan said at the press conference following the policy announcement.

He also said RBI will shortly finalize the methodology for determining the base rate based on the marginal cost of funds, which all banks will move to. That will hasten transmission if banks are able to make at least incremental loans at the marginal cost.

This move will perhaps assuage some concerns of banks that are reluctant to cut rates for all too familiar reasons. With a big pile of bad loans sitting on their balance sheets and return ratios already low, banks are afraid cutting rates would send net interest margins and profitability plummeting.

Secondly, there is hardly any competition because credit offtake remains slow. Hence, banks are not desperate to cut rates and chase loans.

Credit growth is said to lag economic output growth. With better- than-expected second-quarter gross domestic product numbers, there is some hope that bank credit may pick up. That, plus the marginal cost pricing guidelines, may be the impetus needed for transmission.

[“source -financialexpress”]

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