Prime Minister Narendra Modi has said that the government’s demonetisation drive will boost banks’ deposit kitty, and help them lower lending rates. HT takes a look at the whole cause and effect.
How can banks give cheaper loans?
“Deposits have seen a big spike in the days after demonetization, but we will have to see the stickiness of these deposits,” said a banker, who did not wish to be named. What he means is that given the strict exchange limits for getting the new currency, many people are depositing their money into banks, but the duration of these deposits remains uncertain. If most of them withdraw a substantial chunk of the money within the next few days, banks’ deposit base will be back to square one. “If the in-rush of deposits sustains over a period of time, then it creates room for lower rates for retail loans,” said Ajit Ranade, chief economist, Aditya Birla Group.
So if loans become cheap, will it be the same for everyone, especially for the poor and the middle class?
Lower lending rates do not mean that the poor and the middle class will always get cheaper loans. Banks’ lending depends on the customers’ credit worthiness (his credit repayment history, total amount of loans availed till date etc).
What has stopped banks from lowering interest rates so far?
With non-performing assets (NPAs) rising at an alarming pace and deposits remaining stagnant, banks were cash strapped and did not have the flexibility of giving cheap loans.
The repo rate (the rate at which RBI lends to banks) currently stands at 6.25%, but interest rates on home loans vary from 9% to over 10% depending on banks. If the RBI cuts the repo rate, it reduces banks’ borrowing costs and helps them transmit lower rates to borrowers. However, if the surge in deposits continues, banks will not have to wait for the RBI to cut rates, and can pass on the benefits to borrowers.