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Wondering why your EMIs are not coming down? Here’s the low-down

business Updated: Oct 08, 2015 10:56 IST
Gaurav Choudhury
Gaurav Choudhury
Hindustan Times

According to banks, repo rate is only one of the many sources through which lenders raise funds.(HT File Photo)

The Reserve Bank of India (RBI) has cut its key lending rate — the repo rate — by 1.25% points since January. Ideally, floating home loan rates should have come down by an identical margin.

But this hasn’t happened, frustrating both the RBI and millions of customers.

According to banks, repo rate is only one of the many sources through which lenders raise funds. Others include — current account deposits, savings deposits, fixed deposits ranging from one month to several years, borrowings from other banks and institutions, bonds and debentures and through the RBI’s repo and the marginal standing facility windows.

Therefore, a cut in the repo rate does not always prompt banks to cut lending rates in identical margins.

A senior executive of a private sector bank, who did not wish to be identified, said the “base rate”, the floor rate to which all lending rates are linked, was primarily a function of the deposit cost. If the latter does not go down, there would not be a base rate cut.

Bankers said unlike many countries, the Indian system suffers from a peculiarity. While some retail lending rates such as home loans “float”, the main deposit rates are “fixed” both in tenure and interest rates.

When you park money in a fixed deposit, a bank is effectively borrowing from you by offering a fixed rate of return for a period. This limits the banks’ ability to cut lending rates each time the RBI cuts the repo rate, as lenders cannot “borrow” at high rates through FDs and give out long-term loans at lower rates, bankers said.

“There is no one-to-one co-relation between RBI’s action (rate cut) and banks cutting interest rates... banks need to see their liability side too and while repricing the asset side, we need to reprice the liability side as well, and that transmission takes time,” Rajiv Anand, group executive and head, retail banking, Axis Bank said.

Banks also point out that they have to offer high FD rates to maintain attractiveness against competing instruments such as Public Provident Fund and Sukanya Samriddhi Scheme that come bundled with better tax incentives and high returns for customers.

Besides, regardless of the recent volatility, stock markets and mutual funds have been fetching better returns among other asset classes, prompting banks to keep deposit rates high to maintain liquidity. “If the cost goes down, there will be a cut. First, we will reduce deposit rates, then we calculate the base rate,” another senior executive of a leading private sector bank said.

Banks and the RBI seem to be on a collision course on how base rates are to be computed, with the regulator determined to push its way, while lenders resist saying it may not be prudent to do so.

The RBI has proposed that base rate be computed on the basis of the marginal cost of funds rather than the average cost. A marginal or incremental cost approach, according to the RBI, will help faster “transmission” of monetary policy, implying banks will be quick to pass on the benefits to customers every time the RBI cuts the repo rate.

But according to banks it is difficult to implement.

In April, SBI chair man Arundhati Bhattacharya said: “To re-price the entire asset base on the basis of marginal costing itself would be something that even if we think about doing will have a long transition. When rates go down, depositors would start getting much less. When rates go up, borrowers will have to pay much more. How to balance all of it is what we have to see.”