Credit growth is picking up pace. It reached 14.6% by March 1, 2019, during the fiscal compared with 11.1% in the same period last year. Though deposit growth is trailing at 9.8%, it is more than 6.1% of the previous year. With credit growth reviving, bank-lending procedures/norms are undergoing seminal reforms and will turn out to be industry-friendly. Banks will have to gear up internal credit administration to fall in line with these changes, more importantly, the cost efficiency. Following the reduction in repo rate by 25 basis points, there has been an intense debate about lowering of lending rates to help tap growth.
Since banks hardly draw 3% of their resources from the RBI at repo rates, its reduction does not materially alter their cost/income metrics to create space for reducing the lending rate. But even then, many banks have recently reduced their Marginal Cost of Funds Based Lending Rates (MCLR) by 5 to 10 basis points. However, stakeholders continue to pursue banks to transmit reduction of repo rates to borrowers. Lack of speedy transmission of monetary policy signals has always been a contentious issue. But a deep dive into the affordability of banks to reduce lending rates will be interesting.
Lending rate models have undergone a change ever since the RBI deregulated interest rates. But none could ensure satisfactory transmission of interest rate movements in sync with the monetary policy. Marking the end of the administered lending rate regime, the RBI deregulated lending rates for loans of over Rs 2 lakh way back in October 1994. It introduced the Benchmark Prime Lending Rate (BPLR) system in 2003 to create competition and bring better transparency in computation. Lower BPLR demonstrated better efficiency of banks. But, this system led to arbitrariness because banks could lend even below BPLR. It created scope for bias and opaqueness. Mighty borrowers got loans at cheaper rates while others were either deprived or had to borrow at a higher cost. Hence, this system could not continue.
From July 2010, the Base Rate system was introduced based on the recommendations of the Working Group on BPLR led by chairman Deepak Mohanty, with specific provision that banks cannot lend below the Base Rate. This system was replaced with Marginal Cost of Funds Based Lending Rates (MCLR) from April 2016 to overcome the slow transmission of lending rates. Banks were unable to reduce interest rates under the Base Rate system as most of their term deposit commitments continued at old interest rates and cut in repo rate had a nominal impact on their cost structure. The MCLR system too is now set to change from FY20.
Linking with External Benchmark
To ensure transparency and standardisation, all new floating rate — personal or retail loans (housing, auto) — and floating rate loans to micro and small enterprises extended by banks from April 1, 2019, will be linked to any one of the benchmarks – (i) RBI’s repo rate (ii) or to yields of 91 days Treasury Bill (iii) 182 days Treasury Bill, (iv) or any other benchmark market interest rate evolved by the Financial Benchmarks India Private Ltd. However, adoption of multiple benchmarks by the same bank is not allowed within the loan category. Banks can also choose to offer external benchmark-linked loans to other types of borrowers as well.
The State Bank of India, the largest banking behemoth, smartly announced linking of its savings bank deposits to external benchmark – RBI’s repo rate. Starting May 1, 2019, SB account holders with balances of over Rs 1 lakh will get interest rate at 275 basis points below the repo rate that works out to 3.5%. It will bring down SB interest on accounts with balances of over Rs 1 crore also to 3.5% as against 4% now. This reduction of interest rate will thus impact 80% of SBI’s deposit base. It may also prompt some depositors to move to fixed tenure deposits to protect their interest income.
Similarly, on the lending side, the SBI will charge from short-term working capital loans/overdraft borrowers of over Rs 1 lakh, at 225 basis points above repo rate bringing down lending floor rate to 8.5%, which is close to the MCLR ruling currently at 8.55%. Till now, the SBI has kept retail lending out of its purview. Risk premium above such threshold will, however, continue to be based on risk perception of the borrower.
The innovative approach of SBI to convert SB deposits of over Rs 1 lakh into floating rates and linking it to repo rates is designed to suit its asset liability structure. It may not be feasible for other competitors with fragile CASA base to adopt it. But the SBI move would herald a new way of finding solution to eventually create a low interest rate regime to support growth of the economy. This innovation has to be tested to know how customers perceive it.
Other Lending Reforms
The RBI would bring into force its revised Large Exposure Framework (LEF) from April 1, 2019. Under this, the sum of all exposure values of a bank to counterparty or a group of connected counterparties must not be higher than 25% of Tier–I capital of the bank. Hitherto, such exposure measures were linked to total capital comprising Tier I and II put together. Effectively, thereby the exposure appetite of banks to large borrowers may come down unless Tier–I capital base is enhanced proportionately.
In terms of RBI guidelines on loan system for delivery of bank credit, borrowers having aggregate fund based working capital limit of Rs 150 crore and above will now get a minimum level of ‘loan component (working capital loan) of 40% and rest 60% will be in the form of cash credit. Such ‘loan component’ share will be raised to 60% by July 2019. This will reduce uncertainty and volatility in the interbank call money market due to more disciplined use of working capital facilities.
None of these measures bodes well for quick transmission of monetary policy signals in lowering lending rates unless the structural constraint in the management of profitability of banks is addressed. The cost-income structure of banks must permit reduction in lending rates. It calls for overhauling bank’s operating ecosystem to reduce intermediation cost and with full autonomy to create equilibrium between the cost of resources and its yield net of risk.
(The author is Director, National Institute of Banking Studies and Corporate Management, Noida)