The repo rate cannot be the basis for bank loans
The repo rate can only be a signal for banks to reduce or increase their lending rate and it cannot be a benchmark for the same
The latest economic survey contains the following details under the heading Money Transmission – Bank Lending and Deposit Rates.
The RBI has cut the repo rate by 250 basis points since February 2019 (the current easing cycle). The weighted average lending rate (WALR) on new rupee loans decreased by 197 basis points and 133 basis points on outstanding loans during the period February 2019 to November 2021. Systemic liquidity largely excess, forward orientation of the continuation of the accommodative orientation and the external benchmark loan pricing system in some sectors has facilitated monetary transmission.
Pass-through has been slightly higher in public sector banks than in private sector banks in the current global monetary easing cycle, although it was higher for private banks in April-November 2021.
The WALR on outstanding rupee loans fell by 135 basis points for public sector banks and 123 basis points for private banks, while the WALR on new rupee loans fell by 210 basis points. basis for public sector banks and 177 basis points for private sector banks between February 2019 and November 2021.
There are some misconceptions in expecting monetary transmission to be in line with the Reserve Bank of India’s repo rate mechanism. The government and the Reserve Bank of India claim that the external reference system for pricing has facilitated monetary transmission. First, it is not correct to prescribe an external benchmark for bank lending rates. All end product pricing is based on the cost of supply in any industry and banking cannot be an exception. Their lending rate can only be based on the cost of funds (deposits) provided by them. Asking banks to set lending rates based on another rate is completely arbitrary. But surprisingly, no one questions RBI’s wisdom. Then, how can the repo rate be a deciding factor for lending by banks? The repo rate is the rate at which the Reserve Bank of India lends money to commercial banks in the event of a shortage of funds. This is only a temporary arrangement (mostly overnight) in case of mismatch of funds. This is provided by RBI against securities such as treasury bills or government bonds. The pension rate is linked to the “buy-out option” or “buy-out agreement”.
As of January 14, 2022, all scheduled banks had a credit portfolio of Rs 118,52,628 crore. On the same day, these banks had deposits from the public amounting to Rs 164,11,405 crore. The banks had a loan of Rs 94,732 crore from RBI that day. It is therefore evident that the loans of the banks come from the deposits they have raised from the public and are not based on borrowing from the RBI. Of their loan requirements, only 0.79% comes from borrowing from RBI. So how can the repo rate be a determining factor for bank credit?
The repo rate can only be a signal for banks to reduce or increase their lending rate and it cannot be a benchmark for the same. Additionally, when the Repo rate is reduced, there is no automatic reduction in deposit rates by banks and banks’ existing fixed deposit accounts will attract contracted interest rates to maturity. Therefore, there can be no sudden reduction in the cost of funds for banks and forcing banks to cut interest rates for borrowers results in an erosion of the net interest margin for banks.
The economic study also reveals how depositors are overcharged by banks at the request of RBI. During the period from April 2021 to November 2021, banks reduced lending rates (weighted average) on outstanding loans by 19 basis points. They cut lending rates (weighted average) for new loans by six basis points. However, for term deposits, the reduction in the weighted average rate was 24 basis points. This shows how banks are forcing depositors to waive interest rates to help borrowers.
The banks, the RBI and the government are there to favor only the borrowers at the expense of the depositors which cannot be in the long term interest of financial intermediation by the banks. As it is a bank, depositors only receive negative interest when adjusted for inflation. With a projected budget deficit of 6.4% of GDP for the year 2022-23, there may be no respite from inflation for bank depositors and with the budget presented without any relief for depositors banks, difficult days await them.
(The author is a retired banker. Opinions expressed are personal.)