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In order to tide over temporary liquidity crunch, banks borrow from the Reserve Bank of India (RBI), against government securities. The rate at which the RBI lends money to banks, is known as the repo rate. The RBI reduced its repo rate by 0.25 per cent in its bi-monthly review of monetary policy on February 7, 2019. Following this, SBI reduced its home loan rate by just 0.05 per cent, for loans up to Rs 30 lakhs and that too for new customers, without reducing its MCLR and thus, depriving its existing customers of this benefit, as compared to the 0.25 per cent reduction in repo rate by the RBI.
Methodology used by banks to fix their lending rates
The banks used to lend money benchmarked against a rate known as Retail Prime Lending Rate (RPLR). The actual rate charged to the customer, generally used to be at a discount to this benchmark RPLR. This system was opaque. In order to bring in transparency in the lending rates, the RBI mandated that all the banks will have to lend against an internal rate called ‘base rate’ from July 1, 2011, below which the banks could not lend to even the best customer. This benchmark also did not translate into lower lending rate of the banks, whenever the RBI reduced its repo rate. This used to happen, because the base rate was computed after taking into account the overall cost of borrowing of the banks and would only be impacted marginally, by any reduction in the repo rate.
Hence, the RBI again mandated the banks to benchmark their lending against their marginal cost of borrowings, known as the ‘marginal cost of funds-based lending rate (MCLR)’, with effect from April 1, 2016. Under the MCLR regime the banks have to compute their marginal cost of funds and not the average cost of borrowing, as was done under the base rate regime, for determining the lending rate.
Impact of reduction in repo rate on MCLR
Banks are engaged in the business of lending money and for lending, banks have to mobilise resources. For mobilising resources, banks majorly take money from the public, in the forms of deposits. These deposits may be in various forms, like money kept by you in your savings bank account or current account or even fixed deposits.
A major chunk of the resources of the banks are in the form of deposits from the public and the overnight borrowing from the RBI at the repo rate, is an insignificant portion of their overall borrowing. The ability of the bank to lend is dependent on the amount of resources available with them, which in turn, will depend on the demand and supply dynamics of money at any given point of time. Immediately after demonetisation, the banks were flush with funds. However, they were not in a position to deploy the money at that time, due to depressed demand for credit from the market. This forced the banks to reduce the rate of interest on their deposits. The situation has changed now.
The money deposited during demonetisation has found its way out, either through cash withdrawals or to other financial assets. Now, the demand for credit is growing at a higher rate than deposits that the banks are able to garner. As per the RBI, which publishes fortnightly data, the growth in deposits was only 9.63 per cent, against a 14.5 per cent growth in the credit, for the fortnight ended February 1, 2019. For the fortnight ended on February 18, 2019, the numbers for deposit growth and credit growth were 9.69 per cent and 14.61 per cent, respectively. With credit growing at a consistently higher pace, than the growth in deposits, it becomes evident that the banks are starved of funds. In such a scenario, it is very difficult for banks to reduce the rate of interest on deposits, which they need desperately. That banks are starved for funds, also becomes evident from the higher rate of interest offered by some of them to their savings bank account customers. Some of them are offering six to seven per cent to their savings bank account customers, against 3.5 to four per cent offered by others.
See also: Home loan interest rates all banks: Interest rate and EMI in top 15 banks
What should home loan borrowers do when banks don’t reduce home loan interest rates?
As most of the home loan borrowers are, presently, under the floating rate regime, any reduction in the MCLR will impact them. Borrowers who have not yet shifted their home loans from the base rate to the MCLR regime, should immediately migrate to the MCLR regime, as inflation is likely to remain low, leaving scope for the RBI to further reduce the repo rate. Any further reduction in the repo rate, will certainly have an impact on the MCLR of the banks, in future. Nevertheless, it will be difficult to quantify the reduction in repo rate that will be necessary for a reduction in the MCLR, because the MCLR is dependent not only on the repo rate but is an interplay of various factors and market dynamics.
However, interest rates will surely not increase soon and borrowers under the MCLR regime will benefit more than those under the base rate regime, as the transmission of rate cuts will be quicker for those under the MCLR. Borrowers under the MCLR regime should stay put with their lenders for the time being, till the market dynamics change and competition among the lenders intensifies.
(The author is a tax and investment expert, with 35 years’ experience)