Why impact of repo rate cut on lending rates is not immediate – Find out

By: |
Updated: Jul 10, 2020 9:33 AM

Whenever the rate is lowered, it is expected that the banks would lower the lending rate which will help borrowers and enhance further lending and hence assist growth.

The repo rate was lowered in the April 2019 policy to 6%.The repo rate was lowered in the April 2019 policy to 6%.

One of the ways of measuring the efficacy of the repo rate cut of Reserve Bank of India (RBI) is to ascertain how the system has reacted to the change. Whenever the rate is lowered, it is expected that the banks would lower the lending rate which will help borrowers and enhance further lending and hence assist growth.

This is the chain that has been analysed often. There is an argument that the transmission is not as swift as it should be. However, the lending rate which is defined by the MCLR or base rate or more recently the accepted benchmark, is also linked to the deposit rate which has to be altered first as it goes into the cost of funds. As loans get re-priced immediately while only new and renewed deposits go at the new rate, the impact on average cost of deposits would come with a lag. There is a reason for the transmission to be slow which can take a period of over six months provided banks lower the deposit rates—which may not happen across the board depending on the funds situation of various banks.

The repo rate was lowered in the April 2019 policy to 6%. From then on there were three cuts till March 2020 when the lockdown was announced. This was of the order of 85 bps in tranches—one 35 bps and two of 25 bps each to 5.15%. On announcement of the lockdown, RBI lowered the repo rate on March 27 by 75 bps bringing the total reduction in FY20 to 160 bps with the year ending with a repo rate of 4.4%, though the last cut would have an impact in FY21 rather than FY20. Two months later on May 22, RBI further lowered the rate by 40 bps bringing down the repo rate to 4%. Again, the impact would be felt from June onwards.

Response of rate cut on deposits

The RBI presents data on the weighted average monthly term deposit rate on outstanding deposits which gives an idea of how banks re-priced their deposits following the repo cuts. In the first stage of FY20 when the repo rate was lowered by 85 bps the weighted average term deposit rate for all banks came down by around 50 bps with foreign banks and private banks being more aggressive in lowering these rates. These rates are computed on outstanding deposits for the month. The response rate has been around 60%.

Subsequent reduction in repo rate by 75 bps led to a decline of 26 bps for the system in May (response rate of around 35%) bringing a total of 77 bps decline in deposit rates against 160 bps cut in repo rate during this 14-month period. There has hence been a transmission rate of just about 50% in average deposit rates. In fact, post May 22, the average deposit rate on one-year deposits of the banking system based on five large banks came down from a mid-value of 5.7% to 5.375%, a reduction of 32.5 bps. With the repo rate being lowered by 40 bps, the response was close to 80% reduction in the one-year deposit rate.

Transmission on lending side

On the lending side the transmission has been even swifter. In the period of one year up to March 2020, the WALR on fresh loans came down by 94 bps which is more than the 85-bps decline in repo rate. This has been observed across all bank categories with PSBs responding by around 85% and private and foreign banks more than 120%. The 75-bps decline led to 28 bps fall for all banks. Foreign banks had a response rate of over 100%, while private banks did not witness a significant change in WALR. The response of PSBs was around 60%. Hence 160 bps cut for 14 months had WALR coming down by 122 bps which is quite significant with the response of WALR on fresh loans being above 75%.

Edited excerpts from Care Ratings report

Get live Stock Prices from BSE, NSE, US Market and latest NAV, portfolio of Mutual Funds, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Financial Express is now on Telegram. Click here to join our channel and stay updated with the latest Biz news and updates.

Next Stories
1Your Money: Five credit options to finance your festive spends
2Loans: Don’t wait for SC verdict, pay off moratorium dues as soon as you can
3Life insurance: How to calculate returns on insurance policies