Cut your festival spend plan, loan rates may be on the rise

RBI governor Raghuram Rajan has lit the crackers before the Diwali season this year. He increased the repo rate-the rate at which the central bank lends to banks through the LAF window-and decreased marginal standing facility (MSF) rate for banks.

MSF is also a funding window for banks but they have to pay higher rate than the repo rate. As part of its tightening, the RBI had increased the spread between repo rate and MSF rate to 300 basis points from 100 basis points. So, the MSF rate effectively was 10.25 percent. The RBI today brought this down to 9.5 percent, or 200 bps above repo rate.

The RBI move comes even as wide expectation was the market friendly governor will reverse some of the recent liquidity tightening steps. Talks were about a rate cut, not about a rate increase at all.

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Evidently, banks and industry captains are not enthused as already there have been enough signals that interest rates in the economy are on the rise.

[caption id=“attachment_1122797” align=“alignleft” width=“380”]  with the RBI increasing the policy rate, the question on the top of everybody’s mind is will the loan rates increase now?[/caption]

And now with the RBI increasing the policy rate, the question on the top of everybody’s mind is will the loan rates increase now?

Bankers who spoke to CNBC TV18 were not ready to commit anything. Most of them said their asset liability committee will take a final decision on this.

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“It is too early to say whether loan or deposit rates will be increased,” Vijaya Bank told CNBC-TV18.

Whatever the banks say, it is clear that interest rates can only move upward now.

State Bank of India, the country’s largest lender, increased its base rate only yesterday.

Explaining the rationale behind affecting a rate increase just hours before the RBI’s policy review, State Bank of India Chairman Pratip Chaudhary told CNBC-TV18 earlier today that the bank waited for two months to see whether there will be any fall in the interest rates.

After the policy and the unexpected policy rate increase, a visibly upset Chaudhury told the TV channel that the deposit rates will rise for sure.

“The base rate is not so much a function of policy rate. The base rate is the function of banks liquidity position, the ability to meet the deposits and lending situation. Now the busy season has started so there is a huge credit demand, and banks are scrambling for deposits. So the deposits rates could go up, and by in large according to that the lending rates could go up,” he told CNBC TV18.

According to him, the repo window from where banks borrow at cheaper rates is almost non-existent. This is because the central bank’s had narrowed this window by limiting the funds to 0.5 percent of individual bank’s deposits.

“There is no repo rate. There is only MSF rate,” he told the channel, indicating the cost funds for the bank is very high.

The bank can get only about Rs 6,000 crore from the repo window, he told the channel.

Moreover, the reduction in MSF rate is not changing the cost of funds for the SBI. “This is because other banks have increased their deposits rates, so we have been compelled to offer 9 percent on 180 days deposits. So the cost of funding has gone up, and we have increased across the board by 100 basis points, so that’s why our lending prices have also gone up,” he said.

When asked whether he expected banks to increase their lending rates in response to policy rate hike, Governor Rajan said at the press conference after the policy review that banks should set their rates according to their cost funds. They should not look into the future and decide the rates.

“However, I am not going to micro manage that process,” he said.

The bottomline is with the country’s largest lender indicating a possible increase in rates and the RBI adopting a hands off policy, higher borrowing cost for all-individuals and corporates-is going to water down this year’s festivities.