It took a push from the RBI governor for banks to start reducing base rate for lending
Following strong push from Dr Raghuram Rajan, the governor of Reserve Bank of India (RBI), several banks have started reducing their base rate for lending by up to 25 basis points or 0.25%. ICICI Bank cut its base rate by 0.25% to 9.75%, while State Bank of India (SBI), the country's largest lender and HDFC Bank reduced their base rate by 15 bps to 9.85%. Private sector lender Axis Bank revised its base rate by 0.2% to 9.95% while Lakshmi Vilas Bank cut the rate by 15 bps to 11.1%.
With the two rate cuts of 25 bps each, not being reflected in lower interest rates for lending, RBI governor Dr Rajan said, the central bank has maintained a status quo this time until the monetary transmission takes place or lending rates become sensitive to the policy rates.
In a statement, he said, "Transmission of policy rates to lending rates has not taken place so far despite weak credit off take and the front loading of two rate cuts. With little transmission, and the possibility that incoming data will provide more clarity on the balance of risks on inflation, the Reserve Bank will maintain status quo in its monetary policy stance in this review."
Earlier, the RBI announced two rate cuts in January and in March in a hope that it would help reduce lending rate and thus benefit end borrowers. However, it did not materialise. In fact, when there was a status quo maintained by the RBI during 2014, banks were found regularly reducing interest rates on deposits.
In January 2015, RBI, for the first time since May 2013, reduced the repo rate by 25 basis points to 7.75%. The central bank had kept the benchmark interest rate at 8% since January 2014. However, despite huge expectations from borrowers, there was hardly any change in interest charged by lenders.
Now look at the other situation. Whenever RBI announces an increase in its monetary policy rates, housing loan-providers, such as banks and finance companies, are quick to hike interest rates. However, these lenders never show the same efficiency, when there is a rate cut by RBI.
This happens because RBI has given banks freedom to set their interest rates. RBI, in its master circular issued on 1 July 2014, has said, “Banks may, with the approval of their Boards, determine the rate of interest, keeping in view the size of accommodation, degree of risk and other relevant considerations.”
Banks often cite easy liquidity and slow credit offtake as main reasons for cutting interest rates on deposits. According to media reports, the reduction had been due to deposit growth outpacing credit growth, a drop in the money market rates and aligning with the competition, which had already cut the rates.
If at all banks have more liquidity and credit offtake is slower, why the lenders are not lending more or even thinking about reducing interest rate to attract more borrowers? This is not likely to happen. Because, banks, under the leadership of Indian Banks' Association (IBA) appear to be more interested in fleecing customers under different charges. One look at banks’ balance sheet would reveal how much they earning from other and other fee based income, rather than from interest earned.
When there is a rate cut in monetary policy, lenders first reduce their interest rates on deposits and, only when their average cost of funding comes down, they reduce their base rate. Another reason for lenders not reducing their base rate is that such action affects a major chunk of their loan portfolio and, thus, their balance sheet (read profit).
Coming down heavily on banks for not passing the rate cuts to borrowers, the RBI governor said, the notion that the cost of funds for banks has not fallen is 'nonsense'.
While announcing the monetary policy, Dr Rajan said RBI like to encourage banks to move in a time bound manner to marginal cost of funds base to determine their base rate. The Reserve Bank will issue a guideline soon in this regard. This may have prompted banks to cut lending rates, albeit by a small percentage, compared with their reduction for deposit rates.
With the introduction of the Base Rate on 1 July 2010 banks could set their actual lending rates on loans and advances with reference to the Base Rate. At present, banks are following different methodologies in computing their Base Rate – on the basis of average cost of funds, marginal cost of funds or blended cost of funds (liabilities). "Base Rates based on marginal cost of funds should be more sensitive to changes in the policy rates," RBI had said.