As Raghuram Rajan sets out to decide whether to cut rates in the RBI’s monetary Policy review on Tuesday, one factor weighing on his mind is bound to be the fact that banks are yet to fully transmit the earlier rate cuts onto consumers.
Rajan has over the past monetary policy statements stressed on the need for banks to pass on rate cuts so that consumers are able to enjoy benefits in the form of lower home, car and personal loan EMIs. “It is important at this juncture to ensure that current and past policy rate cuts transmit to lending rates. The reduction in small savings rates announced in March 2016, the substantial refinements in the liquidity management framework announced in this policy review and the introduction of the marginal cost of funds based lending rate (MCLR) should improve transmission and magnify the effects of the current policy rate cut,” Rajan said in the RBI policy review on April 5.
However, banks have their own reasons for not lowering lending rates. According to DK Srivastava, Chief Policy Advisor at Ernst Young India, the biggest factor stopping banks is the demand deficiency. “There is demand deficiency in the economy. Borrowers and lenders are responding more to income effect. Global growth has been slow and hence it has led to capacity under-utilisation. Once demand is back, banks would be more inclined to lower lending rates,” Srivastava told FE Online.
Capacity under-utilisation is a factor that Arun Singh, Senior Economist at Dun & Bradstreet India also points to. “Not only is there a demand deficit in the economy in terms of investments, given the capacity under-utilisation, but also that increasingly banks have become risk averse when it comes to lending to riskier sectors of the economy,” Singh tells FE Online.
“Traditionally there has always been a lag between RBI rate cut and the final transmission by banks. However, it is a valid concern by the RBI governor. India Inc always piles pressure on the RBI to cut rates, but it is actually the banks that are holding out. While there is hardly any delay in in the RBI rate cut and a corresponding cut in deposit rates, banks tend to avoid cutting lending rates quickly,” he rues.
Radhika Rao, Economist at DBS Bank also admits that the transmission has been slow, but expects things to get better in the coming months. “RBI has acknowledged that transmission of rate cuts has been a challenge in the past year and the half, and to a great extent has blunted the impact of RBI’s easy monetary policy. While the pass-through through money markets are subject to exogenous factors likely liquidity conditions and risk-appetite broadly in the financial markets, there have been concerted efforts to convince banks to pass lower rates,” she says. “This saw the authorities lower small savings rates and bring the new MCLR into effect to lower the barriers for banks, which are likely to dampen lending rates over the next year. But the pace is more gradual then the past given the additional burden of stressed assets that banks currently face,” she adds.
Rajan is widely expected to keep policy rates unchanged in his credit policy review on Tuesday. The emphasis is likely to continue on the need for banks to transmit rate cuts. Whether banks oblige is anybody’s guess.
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