RBI Governor Shaktikanta Das wants banks to link loan, deposit rates to repo: Will common man get a fair deal finally?

RBI governor Shaktikana Das has pitched for a full transition to repo rate linked interest rate-setting mechanism in the banking sector. In other words, Das wants banks to link both their lending and deposit rates to the prevailing repo rate. Repo rate is the rate at which RBI lends short term funds to banks. Some banks, like SBI, have already adopted this in practice while others are yet to do it. Why does the RBI want another switch in banks’ benchmarking method? Time and again the RBI has expressed its displeasure over lack of proper monetary policy transmission in the banking system. It has been blaming banks for not being transparent enough when setting their lending rates. The regulator has tried to persuade banks to pay attention to the rate cues from the central bank by nudging them constantly. It can’t dictate lending rates to banks because in a deregulated market it’s up to the institutions to decide their rate card. The idea of pushing banks from the earlier BPLR (benchmark prime lending rate) system to the base rate (minimum lending rate) and later to the marginal cost of funds based lending rate or MCLR-based calculation was nothing but to bring in more transparency in the interest rate-setting process. But, no matter what RBI tried, banks still managed to find ways to protect their interest margins. They did so by passing on only a fraction of the RBI rate cuts to the customer when it comes to lending rates, at the same time quickly transmitting the rate hike cues at a much faster pace. In the tug of war between the RBI and banks, the common customer always got a bad deal. [caption id=“attachment_5684541” align=“alignleft” width=“380”] Representational image. Reuters.[/caption] Consider this: If one count from the start of this rate cut cycle, the repo rate, at which the RBI lends short-term funds to banks, has come down by not less than 110 bps. How have banks responded? The benchmark lending rates of major banks have come down by just 15-30 bps. That means, banks still have scope to further reduce their lending rates by at least 80 bps in their lending rates if these entities choose to pass on the full benefit of the RBI rate cuts to the end-borrower. Not only that such a 30 bps cut has not really helped the borrowers, while a quarter basis points decline in deposit rates have hurt bank depositors in a significant manner. Even a 30bps cut wouldn’t make much difference in the EMI burden of a retail borrower beyond a few hundred rupees. On the other hand, every bps cut in FD rates would hurt FD holders’ returns badly. It is in this context that the RBI is asking banks to fix their lending/deposit rates to an external benchmark. Linking the lending rate to the repo will certainly bring in more transparency. Presently, it is up to each bank to choose the benchmark rate to prepare their final rate under the MCLR mechanism. By now, it is clear that the MCLR mechanism has failed to ensure that banks pass on RBI rate cuts to their borrowers. Once lending rates are linked to the repo, banks cannot offer any excuses for lack of transparency in the monetary transmission. But the downside for a repo rate-linked interest rate system is that banks may have to introduce more frequent and probably bigger swings in their rate structure depending on the actions of MPC (monetary policy committee) that could impact floating rate borrowers. Such a scenario will arise in the event of a volatile interest rate scenario. Also, banks still have room to adjust their final lending rates by adding other costs and calculations. So far, banks have always found a way around to protect their interest margins, harming effective monetary policy transmission, no matter what RBI signals through policies. Changing that approach will be a tough task for the regulator. One needs to wait and watch how the new system will evolve and whether it will have the desired impact on monetary transmission.