RBI's guidelines on base rate computation, if implemented in its current form, would reduce base rates by 50 basis points. It also means a one-time profit hit of Rs20,000 crore for banks in FY2017, says CRISIL
The Reserve Bank of India (RBI)'s draft guidelines on computation of base rate, if implemented in its current form, will significantly impact profitability of banks and reduce the base by about 50 basis points, says ratings agency CRISIL.
The RBI guidelines require banks to the ‘marginal cost of funds’ method for base rate computation from 1 April 2016. CRISIL, in a report, said, its estimates show the change in methodology can lower banking system base rates by approximately 50 basis points (bps) from current levels. Crucially, it will reduce banking sector profitability because return on assets (RoA) will fall by 20 bps in fiscal 2017, it added.
Pawan Agrawal, Chief Analytical Officer, CRISIL Ratings, said, “Our base-case is that profitability of banks will have one-time impact of around Rs20,000 crore in fiscal 2017, which would be equal to 15% of the total estimated profit of the banking system for that year. The actual impact will depend on whether the banks will be given a leeway to make this shift over a longer timeframe in the final guidelines.”
Further, for every subsequent 25 bps cut in the deposit rate, profits will be impacted by Rs5,000 crore in a year from the rate cut, CRISIL said.
According to the ratings agency, in an environment of falling interest rates, yields of banks that lend mostly on a floating rate basis will be significantly impacted. Banks with low levels of current and saving accounts, and/or relatively longer tenure term deposits, will also be majorly affected. Nevertheless, in an increasing interest rate scenario, banks will tend to benefit as they will be able to immediately pass on any hike in deposit rate to the base rate, the report added.
"Banks could look at mitigating interest-rate risks by sourcing more short-term deposits and borrowings. However, the flexibility for this would be limited given that they have to implement Basel III rules such as Liquidity Coverage Ratio and Net Stable Funding Ratio, which aim to improve liquidity and lower asset-liability mismatch risks,” says Rajat Bahl, Director for Financial Sector Ratings at CRISIL.
Alternatively, banks could look at offering floating rate deposit products, but this would depend on demand, he added.
The RBI has proposed the changes to ensure faster monetary transmission. The new calculus for base rate will increase the sensitivity of bank lending rates to changes in the RBI’s policy rate.
However, given the impact on profitability, banks may shy away from cutting deposit rates, especially in times of low profitability, which will defeat the objective of quick transmission of cuts in the RBI’s policy rates.
The guidelines will also impact the broader objective of encouraging corporates to increasingly resort to the bond market given that the arbitrage created between rates on bank loans and bonds, due to a lag in monetary transmission by banks, will now disappear, CRISIL concluded.