The transmission in lending rates by banks continue to lag the cuts in the policy rates as well as the deposit rates since January 2015. As against the 175 bps cut in the policy rates by RBI, the banks have cumulatively cut the deposit rates by 215 bps during the period January15 to May 2017, of which 45 bps was done post demonetisation.
While the cut in deposit rates stood higher than the cut in policy rates, the cut of 145 bps in lending rates (60 bps in base rate and 85 bps in one year MCLR) is appreciably lower than cut in policy rates as well as deposit rates.
It is worthwhile to note that half of the cut in lending rates has been effected after the note ban led to a surge in systemic liquidity, which persuaded banks to cut the lending rates. In fact, the cut in lending rates (nearly 73bps) post demonetisation has been higher than the cut in deposit rates (45 bps), despite no cut in policy rates during this period.
Despite the continued overhang of surplus liquidity in the banking system, the ability of the banks to take any major cut in deposit rates remains limited given that higher rates are being offered in small saving schemes. With only 5 bps cut in deposit rates in FY2018YTD, the median 1-year deposit rate for the banks stands at 6.85 per cent as compared to 8.4 per cent interest rates being offered on some of the small saving deposit schemes.
With expectations of status-quo on the policy rate in the upcoming review, the decline in cost of funds for banks and the continued situation of surplus liquidity, there is scope for banks to marginally improve the transmission as they continue to lose good clients to the debt capital markets.
However, with muted credit growth of ~y-o-y 6.4 per cent till May 2017 -- despite the 73 bps cut in lending rates by the banks post-demonetisation -- may deter banks from cutting the lending rates.
Cuts in bank lending rates will only pressure their profitability levels in the absence of credit growth if not supported by a sharp fall in cost of funds. Credit growth has been muted not only because of the demand-side pressures, as the investment cycle of corporates is yet to revive, but also because the public sector banks (which account for a major share of advances), have been struggling for capital requirements, thus creating supply side constraints on growth in the advances.
Hence, in a scenario of abundant liquidity, a modest cut in policy rates is unlikely to be adequate to spur a meaningful pick up in credit growth.
Accordingly, banks may be cautious on further cuts in lending rates despite losing out on incremental business to debt capital markets unless the credit demand and supply side issues are adequately addressed.
(The writer is Group Head - Financial Sector Ratings, ICRA)
