The Reserve Bank of India’s (RBI) decision to stay put on the repo rate was as per market expectations. However, the good news is that with the RBI projecting a softer inflation trajectory in the coming months and coupled with effective food supply management by the government, RBI’s policy stance will remain largely accommodative in the medium term.
Elsewhere, in the policy statement, even after appreciating the apex bank’s concerns about policy transmission, the issues around rate transmission by banks have to be seen from a broader prism. For example, there are extraneous issues that hold back rate transmission. Given that around 40% of bank deposits (current accounts and savings accounts/CASA) are interest rate agnostic, a 125 bps change in the repo rate would only have an impact of maximum 70 bps (60%*125~72) on lending rate. Thus, the decline in the median base lending rate of banks by 60 bps as mentioned in the policy statement is indeed substantial. Alternatively, when 97% of total borrowings of banks are from deposits, the transmission is bound to get impacted. The irony is that deposit rates are also influenced by the rates in the markets for competing small saving schemes. Interest rates of the government’s small saving schemes limit reduction of deposit rates by banks (acting as a floor below which deposit rates cannot fall).
There is also a myth that banks are reluctant to cut lending rates in a declining interest rate regime, but when it comes to raising rates, they are quick off the block. Going by this logic, in July 2013 when rates were raised by 300 bps, most banks decided to hike rates only by a token amount and that too after a sufficient hiatus. The objective was primarily not to burden the common man with unnecessarily rate hikes in a situation of weak demand.
India banks are currently in the midst of a structural change. With 23 new banks coming into the market, the future of the banking industry looks exciting. Is difficult to guess how the industry will evolve in the coming years, but I am sure our banks will come out stronger, cleaner and leaner from such an exercise.