The concern of the fifth consecutive quarterly fall in the GDP growth of the Indian economy resonated in the latest monetary pronouncement of the Reserve Bank of India on October 4, 2019. By announcing a further 25 basis point cut in the repo rate, RBI has complemented the effort of the government to rekindle the ‘animal spirit’ in the Indian economy by announcing a steep reduction in the corporate tax rate. The latest monetary policy has, however, noted that the weighted average lending rate of banks dropped by mere 29 basis points against the 110 basis point drop in the repo rate from February to August 2019. Reluctance of banks to fall in line, led RBI to finally announce that effective October1, 2019, banks should benchmark their floating rate personal and loans (like housing & auto loans) and floating rate loans to Micro and Small Enterprises to either the RBI Repo rate, Yield on 3-months, or 6-months Treasury Bills, or any other benchmark market interest rate published by FBIL.
One may recall the progression of the regulatory stance on the lending rates of banks over the years. In the regime of the Maximum Lending Rate (MLR), the regulatory focus was to curtail the possible over-jealous pricing attitude of banks that can hurt borrowers. In the Minimum Lending Rate regime, RBI tried to ensure that banks avoid over-reaching prospective customers in the face of competition. It then moved to the regime of Prime Lending Rate (PLR) in October 1994 and then moved to Benchmark Prime Lending Rate (BPLR) in April 2003. RBI then nudged banks to move to the Base rate system in 2010 and to the Marginal cost of fund based lending rate (MCLR) in April 2016.
A tardy response of the banking system to ensure the transmission of the monetary policy led RBI to set-up the Janak Raj Committee (JRC). JRC, in its report on October 2017, observed that it is due to ‘extreme rigidity’ of savings account and the term deposits being at fixed rate banks are reluctant to ensure smooth transmission of the policy rate to their lending rates. Banks fear that anchoring deposit rates to external benchmarks would increase the rate sensitivity of their deposits balances. The rate sensitivity may be sharper in savings deposits, which constitute about 30 to 35 percent of the deposits of the scheduled commercial banks. In May 2019, State Bank of India (SBI) took the lead to link the rate on savings deposits accounts having a balance of above 1lakh would be the repo rate minus 275 bps. RBI reduced its repo rate by another 35bps August 7, 2019. SBI quickly responded by announcing that savings accounts with balances above rupees one lakh would earn 275bps below repo rate with a floor of 3 percent. It had announced that savings accounts with balances up to Rupees one lakh would earn 3.5 percent per annum. The Bank has later announced that with effect from November 1, 2019, the interest rate on savings accounts with balance up to 1lakh will go down to 3.25percent.
It is, therefore, not the ‘size’ of the bank that matters, but it is the fear of ‘unknown-unknown’ about the rate sensitivity of Indian households. It is feared that any perceptible reduction in the interest rate in the savings deposit may force depositors to examine options in liquid mutual funds. The set belief of the ALCO of banks on the core component of savings deposits, which is estimated to be around 85 percent, may suddenly change due to the lowering of the rate below a threshold. Such a tectonic shift might cause unforeseen ripples in the NIM of banks: funding stability which banks have enjoyed in India and hence needs careful planning.
Given this perspective, individual banks should carry out a taxonomy of the accruals in savings deposits, the rate differentials of term deposits vis a vis returns from debt mutual funds and the like including the PPF. Simultaneously, banks should take a close look at its home loan, auto loan, and the MSME loan book to assess the growth profiles in the recent times, say, five years to match the relative growth profiles of the core savings deposit and retail term deposits. The pool PDs in each segment of loan products would become handy to banks to arrive at the spread to be charged as they anchor the lending rates to the repo or the other benchmark rates. It will be interesting to point out that banks started tinkering the interest rate payable on savings deposit in view of the fact that as per RBI data, the RAM segment accounts for about 39 percent of the loan book of the scheduled commercial banks when savings deposits account for about 35 percent of their deposit base.
The government has adopted a ‘big-bang’ approach to MSME lending. Speedy dispensation of credit to MSME (PSB Loan in 59 Minutes) under the EASE Agenda needs to be commensurately backed-up by equally strong due-diligence, and the post-sanction monitoring mechanism in banks. Moreover, the external benchmark based lending rate sounds attractive to the MSMEs in a falling interest rate environment but, the opposite would be true as the rate moves north, causing stress. Suitable advisory should be issued to the borrowers when external benchmark based loans are being offered. Similarly, depositors, especially the senior citizens in the country, whose deposits constitute about 25 percent of the savings deposit of banks, would also appreciate an assurance about the range in which the deposit rate is expected to fluctuate, at least in the short-run. A ‘cap and floor’ for both lending and deposit rate should, therefore, become the order of the day. It is no doubt true that in the rea of floating rates, banks will have to develop a robust mechanism to monitor their earnings volatility and work out appropriate strategies to immunize the same.
Asish Saha, Professor, Finance & Accounting, FLAME School of Business, FLAME University, Pune; Former Director at the National Institute of Bank Management, Pune during 2001 to 2011
- Prof. Ashish Saha, Ph.D. – Commerce | University of Calcutta - Kolkatta