After 3rd repo rate cut, will banks lower lending rates? - Pragnya IAS Academy - News Analysis.

After 3rd repo rate cut, will banks lower lending rates?.

• RBI has cut the repo rate thrice since February, with the latest reduction on 6 June.
• Despite the repo rate—the interest rate at which RBI lends to banks—dropping from 6.5% to 5.75%, banks haven’t cut their lending and deposit rates. Mint looks at whether RBI will be lucky the third time around.
1) How do interest rates of banks look since the beginning of 2019?
Two different interest rates need to be considered. First, the rate at which banks have been borrowing and second, the rate at which they have been lending. The weighted average interest rate on term deposits of banks was 6.91% in January. By April, it had fallen by six basis points to 6.85%. One basis point is equal to 0.01. During the same period, the weighted average lending rate of banks has risen by four basis points from 10.38% to 10.42%. What this tells us is that in terms of outstanding loans of banks, the interest rates of both borrowing and lending have barely moved.

2) Why is that the case with banks?
Since January, the credit to deposit ratio of banks has been 77% or more, except on one occasion—the fortnight ending 10 May—when it stood at 76.9%. Banks need to maintain a cash reserve ratio of 4% with the central bank. They also need to maintain a statutory liquidity ratio of 19% by investing in approved government securities. After adjusting for cash reserve ratio and statutory liquidity ratio, it is clear that banks are lending out almost all the deposits they have. Hence, they are not in a position to reduce interest rates on their deposits as they need fresh deposits to keep funding their loans.
3) What does this mean?
With banks not being in a position to cut interest rates on their deposits, the question of reducing interest rates on their lending does not arise. Deposit growth stood at 15.3% in 2016-17 due to demonetization. It fell to a more than five-decade low of 6.2% in 2017-18. Deposits gathered in 2016-17 helped banks for a while. After that, the deposit growth slowdown started to hurt and that has primarily led to a situation where banks have not been able to cut down their borrowing and lending rates despite RBI’s repo rate cuts. To enable banks to cut rates, deposits need to grow faster, so as to bring down the credit-deposit ratio.
4) How has deposit growth fared in the recent past?
In 2019, deposit growth of banks has been close to 10%, much better than in 2018. The annual deposit growth needs to increase a little more and reach around 12-13% before banks feel confident about cutting interest rates. In 2017-18, interest rates on deposits had crashed in the aftermath of demonetization, leading investors to look at other avenues.
5) Are lending rates likely to be reduced?
One impact of the crisis at non-banks is that more money will now move into banks. This should help in faster deposit growth. But this will take time. Banks need to hold on to the interest rates on their deposits for the next few months, so that their deposit growth is robust enough to get the credit-deposit ratio below 75% and help them cut interest rates after that. (Source: Livemint)


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After 3rd repo rate cut, will banks lower lending rates?.

Why RBI should change its repo rate stance - Pragnya IAS Academy - News Analysis.

Why RBI should change its repo rate stance.

RBI has to walk the fine line for balancing the interests of the saver and borrower.

Interest rate is a very important variable in any economy. It impacts investments by entrepreneurs for creation of capacities, i.e. growth, it impacts financial investments, and retail borrowings for consumption purposes, e.g. house, car, etc. The fulcrum for deciding the spectrum of interest rates in our economy is the RBI repo rate, currently at 6.5%, which is taken as the signal rate for the ecosystem. On its part, the RBI looks at many factors for deciding the repo rate, the most important parameter being inflation, as the real interest rate in the economy should be positive in the interest of savers. Other factors are GDP growth rate, currency exchange rate, global interest rate movement, etc.

What is the objection to the hawkish stance? When interest rates are high, vis-à-vis inflation, it is loaded in favour of the saver, which is fair to that extent. However, the RBI has to walk the fine line for balancing the interests of the saver and borrower. Capital is an important ingredient for production, and a higher-than-warranted interest rate is disincentive to the entrepreneur, since money is available to her at a relatively higher cost. In a way, the ecosystem is giving a message to the entrepreneur that we do not want you to create fresh capacities, which would have led to economic growth for the country. Same logic applies to personal consumption loans as well; if loans are available at attractive rates, consumption purchases like house or car or domestic appliances would lead to demand, and thereby have better growth for the economy.
Currently, not only is inflation on the lower side (2.33% in November), RBI’s projections are on the lower side as well. In the MPC meeting held on 5 December 2018, the inflation projection is 2.7-3.2% for the period October 2018 to March 2019 and 3.8-4.2% for April 2019 to September 2019. This is benign, very much within RBI’s target inflation rate of 4%. That being the case, rate hike bias is inimical to growth prospects for the country. Economists are discussing the probabilities of interest rate cuts in 2019, driven by benign inflation. However, for the RBI MPC, prior to a rate cut action per se, the outlook has to be changed. It is not possible for them to reduce interest rates while maintaining a hawkish rate stance; it has to be changed to neutral. The next meeting for the RBI MPC is scheduled for 7 February; it is high time they change course in the interest of growth of the country. The other possibility is change of stance and rate action on the same day, but that may be expecting too much. Hence, the likelihood is, they would shift to neutral on 7 February 2019 and take rate action in April 2019, depending on inflation trajectory and other relevant parameters. The biggest component of CPI, which is food, has seen a consistent decline over the last five years, and is currently negative on year-on-year measurement. Though food inflation would not remain negative in 2019, there is a structural improvement in food inflation, and the benefit should be transferred to the economy in terms of lower interest rates.
Net-net, given the higher likelihood of interest rate cuts in 2019, it would be better for your home or car loans, but please take care of financial planning. Things should be proportionate and loans should be within a certain percentage of your net-of-tax earnings. Lower interest rates are better for your existing investments as well; equities driven by better earnings prospects of companies (lower interest cost) and debt driven by interest rates coming down (bond prices move inversely with interest rates). Lower interest rates are not so good for fresh investments in debt, as you would be doing it at relatively lower interest rates, but the impact would not be as much as to alter your portfolio allocation decision.(Source:Livemint)


The above Article can also be read using the link below:

Why RBI should change its repo rate stance.