For nearly two decades, every time the RBI changed interest rates, bank CEOs standard refrain was: “Our ALCO (asset-liability committee) would meet soon to decide.” They dont say it anymore.
These days the ALCOs seem to be meeting ahead of the RBI and more often, leaving the Monetary Policy Committees rate actions less relevant for banks than before. The monetary transmission question is back, but in a different way.
Five of the countrys biggest banks that account for a loan share of 40 per cent raised their lending rates just days before the MPC announced a 25-basis point increase in benchmark lending rates last Wednesday to 6.25 per cent — the first rate hike in four years. A basis point is 0.01 percentage point.
“Repo rate has lost relevance to the extent that liquidity has become more important,” says Saugata Bhattacharya, economist at Axis Bank. “But short rates are more driven by the RBI policy rates such as repo and term repo rate.”
Banks that raised rates are State Bank of India, ICICI Bank, Punjab National Bank, Union Bank of India and Kotak Mahindra Bank. Even HDFC, the countrys largest housing finance company, raised lending rates on June 1 with these banks.
Yields on benchmark 10-year bonds have risen 71 bps from lows of 7.12 per cent on April 5, 2018 to 7.83 per cent on June 5, a day before the RBI raised rates. So did the cost of funds for banks and companies.
The decision to tinker with rates even before the RBI does raises questions about the relevance or perhaps the irrelevance of the RBIs stance on policy rates. So what has changed? The answer probably lies in the way banks calculate their lending rates now as compared to the past.
It was all thanks to RBIs own overdrive in mandating a formula when it was frustrated by the lack of transmission of lower rates by banks even when interest rate was on a downward rate cycle between January 2014 till recently. When policy rates were reduced, the mean lending rate went down by 200 bps, a research by RBI showed.
So, it came up with the so called Marginal Cost-based Lending Rate, or MCLR, which ordered banks to fix their best rates, or minimum lending rates based on their cost of funding for fresh borrowings. This was aimed at lowering the cost for borrowers. Earlier, under the base rate system, banks calculated lending rates based on the average cost of funds.
In fact, in a desperate attempt to pursue banks to pass on the benefits of lower rates, Raghuram Rajan, the then governor of RBI, had said in April 2014, “We want to facilitate the process of transmission. I do not see an environment where credit growth is tepid, banks are sitting on money and their marginal cost of funding (has) fallen, the notion that it hasnt fallen is nonsense, it has fallen.”
Not all banks have raised deposit rates, although deposits have significant share of banks overall funding. So, the cost of other borrowings such as certificate of deposits or term repo rates — may have gone up leading to higher cost of funds.
“MCLR is more receptive in tracking the market rates,” says Madan Sabnavis, economist at CARE Ratings. “The incremental cost of borrowing has gone up and, therefore, the MCLR has gone up. But at the same time, their average cost of funds has not gone up much.”
So what is the relevance of repo rates? It is more a directional and psychological tool to indicate the policymakers thinking. Also, there is realisation at the policymakers level that liquidity plays a more important role in determining market rates rather than policy rates. Banks cost is determined by rates they pay to secure funds and not what they pay central bank to meet their liquidity needs, where repo rate comes into play.
“Also, considering that it is a very small portion of banks borrowing, nothing forces banks to lower rates to pass on the benefit to the borrower,” said a bank chief who did not want to be named.
The RBI, after sticking to the belief that a deficit liquidity situation is better for transmitting its policy rates, has shifted to a neutral stance, giving a much needed relief to banks. To that extent, liquidity stance would remain more relevant than policy rates.