The Reserve Bank of India’s move to compel lenders to link all new floating rate retail loans to external benchmarks is unlikely to achieve the intended goal of reducing interest rates sharply for consumers anytime soon, bankers and analysts said.
The RBI late on Wednesday ordered all banks to link certain loans to the external benchmark-based interest rate from Oct. 1, saying banks had not satisfactorily passed on the benefit of recent policy rate cuts to consumers.
“Rates may come down by a few basis points (bps), but it’s not that home loans, which are in the range of 8-9%, will reduce to 6%,” said the chief financial officer of a private bank, requesting anonymity.
“This is because banks are going to increase their spreads to manage their cost of funds as well,” he added.
The RBI, which has stressed the need for passing rate cuts faster to consumers, has since February reduced its benchmark repo rate by 110 basis points. Most Indian lenders that rely on an opaque rate-setting mechanism that takes into account their own costs, have not kept pace.
For example, State Bank of India (SBI), the country’s largest lender by assets, has cut its benchmark lending rate by only 30 bps since February.
The government and RBI have pushed for better transmission of rate cuts as economic growth has slumped to a six-year low. But banks are reluctant to do so as they grapple with high deposit costs and are also burdened with about $150 billion in stressed assets.
“Banks will need to better manage their interest rate risks, either by widening their deposit product offerings by pricing floating rate products more attractively than fixed rate products, or through interest rate derivatives,” said Anit Gupta, vice-president and co-head financial sector at rating agency ICRA.
Banks argue that their cost of deposits cannot be re-priced in the short term and they will have to rely on spreads to protect their margins.
“For several banks, most of their funds are in public deposit, where the rates cannot be reduced overnight or else the banks will suffer adversely on net interest margin. Therefore, the only option is to have the spread as a buffer,” said the retail head of another public sector bank.
The RBI has said that banks are free to decide the spread over the external benchmark.
While bankers agree that transmission will surely be faster compared to the existing regime, they warn that it also means that consumers will be hit by rising interest rates faster when the rate cycle turns.
There are also concerns about how the new policy will be implemented.
“India’s banking system’s liability side is not equipped to handle such a structural transformation … so to expect banks to borrow fixed and lend floating rate, especially at rates linked to an external benchmark, may not be practical,” Suresh Ganapathy of Macquarie Capital Securities said in a note.