Do sequential rate cuts augur well for the economy?

Repo rates ingested a slash by further 40 basis points, from the recent RBI’s off-cycle meet. June 3-5 was the programmed schedule for the MPC (Monetary policy committee) meet. As circumstances have upended the economy, since the pandemic outbreak, the RBI has advanced its announcements, leaving the market astounded. Repo rate amendments have always been a customary part of MPC meets and not standalone announcements. The bureaucrat turned governor also hinted on India marching towards negative territory over GDP growth rates The governor assured of further measures and assistance as and when circumstances necessitate.

Will rate cut benefits be passed on to public?? Earlier, banks followed the pracitce of enjoying debt at cheaper rates from RBI, while loan rates to the public would continue to stay put. Astutely, deposit rates would be slashed, aiding banks to improve their margins with no additional efforts. This delinquency has been a longstanding deterrent in rate cut transmissions to the public. Gramercy to the RBI’s stance! which made it mandatory for banks to link their lending rates to an external benchmark. The question in line is “What are those benchmarks?” Repo rates or Treasury bill rates. The former being the rate at which banks borrow from RBI and the latter, being the rate at which RBI borrows from the banks / public. So every floating rate loan is linked to an external benchmark, assuring rate cut/hike transmission.

Constituents of the lending rate: In the new era of benchmark-linked lending rates, there are three factors to it. Principally, the chosen external benchmark by the bank. Secondly, spread / margin of the bank (difference between deposit & lending rates). Finally, the credit risk premium (vis-a-vis credit rating of the borrower and collateral ratio – collateral/principal at market values). Fortunes are favourable for floating-rate adopters!! incumbent.

Will rate slash spur credit growth?? Standalone, nay. Borrowers are infinitely cautious to take up additional credit despite munificent relaxations from RBI. The moratorium on interest payments have been augmented further by another quarter & working-capital loans have inherited the option to convert as term-loans. Group exposure limits have been enhanced to 30%. Basically, group exposures are major contributors for the collapse of financial institution. So to circumvent such a catastrophe, banks have to abide by the ceiling limit. Give a thought on, how Yes Bank shares nosedived on the news of CG-power scandal. In fact, the imbroglio still persist. Banks are infinitely cautious to lend to parties with a chequered past.

Conundrum on excess liquidity: Banks are currently inundated with exorbitant liquidity, as depositors are locking in advances with the eclipsing gloom of deposit rate cuts. With restricted scope on credit growth, banks are left with no option but to deposit the same with the RBI @ reverse-repo rate. (Reverse repo rate have also been slashed to dissuade banks from parking their surplus with RBI). Banks currently borrow at 4% from RBI, depositing the same at reverse repo (3.35% ) would further dent their margins.

The current juncture appears to be a boon for borrowers but a bane for banks & depositors.

-Arunachalam Sivaraman

Published by adithyaarunachalam

I'm a millennial, from Chennai, India. Passionate about building up a career in finance, I follow and stay abreast on news feeds. I'm a novice blogger, So feel free to pass on your conjecture to me

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