RBI’s CRR step won’t make your loan cheaper
The central bank’s recent measures to lower interest rates for consumers and small businesses are unlikely to benefit them and instead deliver some collateral gains to corporate borrowers, whose interest rates are still set on the marginal cost of the bank’s funds.
This is because from 1 October, all retail and small business loans have moved to the new external benchmark-based lending rate—it’s the repo rate for almost all banks—from the earlier marginal cost of funds-based lending rate (MCLR) framework. While MCLR is based on a bank’s incremental cost of funds, loans that are linked to external benchmarks such as the repo rate change only when there is a movement in the benchmark.
While the Reserve Bank of India’s ₹1 trillion credit window and exemptions from setting aside money as cash reserve ratio (CRR) will lower the cost of funds for banks, it won’t reduce interest rates for loans that are linked to the repo rate, according to chief executives of Union Bank of India and Punjab National Bank (PNB).
The lower cost of funds will allow banks to only pass on the benefits to borrowers whose interest rates are based on MCLR, they told reporters on the sidelines of separate press conferences to announce their December quarter earnings last week.
“In case of MCLR, the cost of deposits will change and for external benchmark, the repo has to change. See, the risk premium for external benchmark does not change easily,” said Rajkiran Rai G., chief executive of Union Bank of India.
The repo rate loans have two components to it, a benchmark and a spread. Rai explained that under RBI’s norms, the spread cannot be changed frequently and since the repo rate has not changed since October, a change in lending rate is not possible.
“The CRR benefit will not have much impact on the interest rates and it will be more on the MCLR side, not on the external benchmark side. Actually, most of the housing and small business loans are happening on the external benchmark rate; so, the CRR reduction is not going to have an impact on those loans unless the repo rate changes,” said Rai.
In its 4 September notification, RBI said banks are free to decide the spread over the external benchmark, however, credit risk premium may undergo a change only when a borrower’s credit assessment undergoes a substantial change.
It also said that other components of spread, including operating cost, could be altered once in three years.
According to S.S. Mallikarjuna Rao, chief executive of Punjab National Bank, the lender will not be able to pass on benefits to retail loans as those are already linked to the repo rate.
However, Rao said the bank can think of using another benchmark in the months ahead, like the treasury bills or government securities for pricing its loans.
Although RBI provided banks the option to choose from a host of external rates, almost all banks chose the repo rate and the liquid nature of other benchmarks might have made PNB think of adding another rate to the kitty. RBI regulations do not permit banks to use multiple benchmarks for a single category of loans.
The central bank’s efforts were aimed at reviving wilting credit growth owing to a mix of lack of demand and corporate deleveraging in a sluggish economy. Non-food credit declined to 7.14% in the fortnight ended 17 January compared to 7.51% in the previous fortnight.