Such benchmarking could protect the interest of retail savers and help the system achieve quicker transmission. Banks would be comfortable if bulk deposits are floating rates and would be more willing to pass on as well, by having repo-linked loans. Since no bank can do it alone, it needs to be an RBI decision for the implementation to happen
The Reserve Bank of India (RBI) has deregulated the interest rate structure and has moved from the prime lending rate (PLR) to base rate to the marginal cost of funds-based lending rate (MCLR) for better transmission. Recently, RBI has been pushing banks to benchmark loans to an external benchmark, as conspicuous transmission is not happening. Until now, the transmission has been slow, even though this is the fourth rate cut in a row—the policy rate is down from 6.25% in February 2019 to 5.4% now. During the same period, banks have, on an average, transmitted around 40 basis points through their MCLR, with public sector banks transmitting more than private sector banks.
The case of the State Bank of India (SBI) is bit different. Due to the linking of savings bank deposits with balances above Rs 1 lakh and short-term loans (cash credit accounts and overdrafts with limits above Rs 1 lakh) to the repo rate, the SBI floor rate (repo-linked lending rate, or RLLR) for short-term loans has declined from 8.5% (at the time of announcement of linking) to 7.65% (a whopping reduction of 85 basis points), effective from September 1, 2019. The SBI has also introduced a repo-linked home loan product.
However, to be fair, for external benchmarking it is not possible for banks to only link the asset side of the balance sheet as it will create ALM (asset and liability management) mismatch—as close to 35% of bank liabilities are savings bank deposits. Further, banks are also not able to link external benchmark to the entire liabilities (especially time deposits), as the floating term deposits are not accepted by Indian depositors and have already been unsuccessfully experimented by some peer banks in India.
Therefore, the key to effective transmission, we believe, is adjusting either savings bank deposits or time deposits. Savings bank deposits typically serve the transaction needs of the depositor. The option is always available with the customer to transfer the surplus savings bank deposit balance to time deposits. However, the problem is that it cannot be done in isolation by any one bank, and must be enforced by the regulator.
The best option for us is to link the bulk deposits within time deposits to an external benchmark/floating rate. In India, single rupee deposits of Rs 2 crore and above (since February 2019, earlier it was Rs 1 crore and above) are considered as bulk deposits, and banks have the discretion to offer differential rate of interest on bulk deposits as per their requirements and ALM projections. The share of bulk deposits (Rs 1 crore and above) in banks’ total deposits was in the range of 32-38% in the period between March 2016 and March 2018. This was more than 40% in some fiscal years also, but with the revision of definition we believe that this share is currently around 30% of total deposits. Needless to say, most of the bulk deposits are from institutions.
It is, therefore, logical that large institutions could afford to take interest rate risk as this would spare the retail depositors from taking the same. Specifically, with India currently aiming towards becoming a $5-trillion economy, it is imperative that the interest rate derivative market expands. Just to put it in a different way, currently, all kinds of risks—be these FX, credit or rates—are all largely warehoused in the banking system itself, and with the economy growing, we must diversify this risk across the financial market at arm’s length.
However, most importantly, such benchmarking could protect the interest of retail savers and help the system achieve quicker transmission. We believe that banks would be comfortable if bulk deposits are floating rates and would be more willing to pass on as well, by having repo-linked loans (as their spreads get locked with more stability in the net interest margins). Since no bank can do it alone and sail through, it needs to be an RBI decision for the implementation to happen. It is, in fact, pertinent to initiate a discussion on this.
It may also be noted that, in India, interests on deposits are an important source of income for many, particularly rural and middle class segments. For example, savings bank interest income currently constitutes 1.8% of the private final consumption expenditure (PFCE) of individuals. However, interest incomes on time deposits are nearly 10% of PFCE, and hence any effort to go beyond savings bank deposits and subsequently linking time deposits with market rates could introduce a significant spike in the consumption patterns of individuals. This could also result in a concomitant decline in income velocity of money, as it could then be used more for precautionary purposes. This is not desirable for economic activity, though.
Even as transmission remains a challenge, we believe that banks can reduce deposit rates and align the real deposit rates that are as high as 4.45%. Our estimates suggest that bank deposit rates remain the largest constraining factor in rate transmission. For example, a 100 basis point cut in deposit rates could result in 45-50 basis point reduction in lending rates. However, in a developing country like India, cutting deposit rates always remains a challenge, given that a large populace of senior citizens depends on interest income from deposits as a source of livelihood.
Interestingly, contrary to popular belief, small savings rates are not a large constraining factor as incremental small savings collections are merely 11% of incremental deposits.
Finally, interest rates offered on deposits in India are demography-agnostic (barring the separate rate for senior citizens) by regulation. However, going forward, in our view, RBI could consider an age-wise interest rate structure, with rates linked to long-term bank deposit rates till a certain age group, and offering a higher-than-market rate over that age group. This could, in one go, serve the multiple purposes of (1) ensuring a lower lending rate structure, (2) adequate returns for senior citizens, (3) lower interest expenditure, and (4) an alternative to floating rate deposits.
The author is group chief economic advisor, State Bank of India. Views are personal