RBI rate cut: lending rate may not fall anytime soon as banks struggle on many fronts
by Karthik Srinivasan
The 4:2 vote in favour of a front-ended 25bps rate cut by the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) accorded greater focus to growth in the last bimonthly MPC statement of FY19 as inflationary indicators continued to remain benign. While RBI expressed hope that banks would pass on the benefit to borrowers, which can boost investments and private consumption, we believe the transmission, as in the past, would happen only with some lag. The lending rates of banks are outcome of their own borrowing costs, primarily deposit costs, and unless their deposits become cheaper, it may be difficult for banks to reduce their lending rates. Accordingly, borrowers may need to wait for cuts in benchmark lending rates of banks and lower EMIs.
For the nine-months ending December 2018, the incremental growth in bank deposits stood at `3.43 lakh crore, as against an incremental credit growth of `6.75 lakh crore, and the credit-to-deposit ratio of the banking system touched a high of 78.7% as on December 2018 as against 74% in March 2018. The pace of deposit accretion with the banking system as on December 2018 has not kept pace with credit growth of 15.1% over the same period. To improve transmission of policy rates, competition among various lenders needs to be increased, which can happen when more PSBs exit the prompt corrective action (PCA) framework and non-banking financial companies (NBFCs) have access to adequate funding at competitive rates.
With some PSBs coming out of the PCA framework, and cleaning up of balance sheets of many other PSBs, the competition in both lending as well as deposit activity is expected to place an upward bias on deposit rates rather than a reduction, and a cut in lending rates will mean sacrificing profit margins.
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Given the need and relevance of NBFCs for Indian credit markets and improving their access to funds, the measure to align the risk weights for bank exposures to NBFCs (excluding core investment companies) on their externals is a step in the right direction. We estimate banks’ exposure to NBFCs at `5.7 lakh crore, of which exposure to asset finance companies, infrastructure finance companies and infrastructure debt funds is already risk-weighted based on their ratings. Based on our assessment, the revision in risk weights on exposure to NBFCs should help banks release capital of nearly `125 billion (estimated at around 0.125% of risk-weighted assets), which now can be used for incremental lending or bolster the existing capital ratios. While incremental credit supply for NBFCs is expected to improve, reduction in rates would depend on banks’ willingness to do so. Accordingly, unless NBFCs can avail fresh funding at competitive rates, their ability to lower the lending rates for end-borrowers may remain constrained.
To ease out liquidity deficits and preventing sharp rise in interest rates amid the overhang of high borrowing programme of central and state governments, RBI has been doing large-scale open market operations and has been purchasing government securities worth `2.75 lakh crore during April-February 2019, but liquidity conditions have continued to remain in deficit mode since June 2018. Attracting foreign flows and easing liquidity conditions are some factors that can support lower cost of funds for banks and NBFCs, and support their abilities to reduce their benchmark lending rates. In the absence of this, even another rate cut may not result in reduced borrowing costs.
With India entering an uncertain election cycle, foreign investor demand will also remain muted until there is clarity on the next government and its likely macroeconomic policies. So, despite a general wave of bullishness towards emerging market assets on the softening stance of the US Federal Reserve, India is unlikely to be a key beneficiary till at least May 2019. Nonetheless, the change in stance to “neutral” from “calibrated tightening” would aid RBI to cut rates again next fiscal if inflation estimates for FY20 remain under 4%. However, given a divided vote and impending general elections, we expect the MPC to adopt a wait-and-watch approach and assess the data related to agricultural output from rabi harvest, monsoon forecast and fiscal policies adopted by the new government before any further rate action.
Senior vice-president & group head, Financial Sector Ratings, ICRA Ltd
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