In a bid to disincentive banks from parking their excess funds with the RBI under the reverse repo window, the central bank slashed reverse repo rate to 3.35 per cent, a fall of 155 basis points so far this year. This is higher than the 115 bps point reduction in policy repo rate.
Reverse repo rate is the rate at which banks lend short-term funds to the RBI, while repo rate is the rate at which banks borrow short term funds from the central bank.
The steep fall in reverse repo rate to decadal low levels has not dissuaded banks from parking surplus funds with the RBI. According to the RBI’s latest July report, average deposit of funds in the overnight reverse repo window increased more than three times – from an average of ₹2.4-lakh crore during the March quarter to ₹7-lakh crore during the June quarter. In the month of May, banks parked nearly ₹8-lakh crore under reverse repo on daily average basis.
With banks remaining risk averse to lending, they appear to have been comfortable parking surplus funds under reverse repo despite the meagre returns. At 3.35 per cent, the reverse repo rate is the lowest in the past decade; it had last touched 3.25 per cent in April 2009.
Current credit growth in the banking system is at about 6-7 per cent. With banks benchmarking their loans against external benchmarks (mostly repo) from October last year, lending rates cuts have been sharper, hurting banks’ net interest margins. Parking large sums of money under reverse repo will weigh on profitability further, though cut in fixed deposits rates and savings rate offer some cushion.
Widening policy corridor
After the 135 bps reduction in repo rate in 2019, the RBI slashed policy repo rate by 75 bps in March to 4.4 per cent. But it reduced reverse repo rate by a higher 90 bps to 4 per cent (widening policy rate corridor to 40 bps from 25 bps earlier). This was done to make it unattractive for banks to park their surplus with the RBI and induce them to lend.
Again, in April, even as the RBI kept the repo rate unchanged, it cut reverse repo rate further by 25 bps to 3.75 per cent, widening the gap between the two policy rates to 65 bps.
In May, the RBI cut repo rate further to 4 per cent, and commensurately reverse repo rate fell to 3.35 per cent.
Ideally, at such low rates, banks should be dissuaded from parking money under the reverse repo window. This is because banks until recently were offering 3.5-4 per cent interest rate on savings deposits, and it wouldn’t make sense for them to park money at such low reverse repo rates.
But to cushion the impact, banks have been cutting rates on savings deposits. SBI had cut its savings deposit rate to 2.7 per cent last month (for deposits up to ₹1 lakh). Many other leading banks offer 3 per cent on low value savings deposits currently.
To further ease the impact on margins on account of lower credit growth and fall in lending rates, banks have been slashing fixed deposit rates across tenures (about 100-150 bps since March).