RBI Policy Rates and the commercial banks lending rates: A discrepancy in the rate action By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

January 19, 2015 | Posted by bobbysrinivasan << back to blog

Whenever RBI slashes the policy rate, namely the repo rate; which they did on 15.01.2015 by 25 basis points, it is believed that the reduced rate will be immediately passed on to the customers. However the recent evidence shows that this may not be case. The question arises as to what the customers should do, if the banks that they deal with do not pass on the full benefits to them. This is a conversation between a student and his finance professor.

Student: Prof., I read in the papers that RBI’s repo rate which was reduced by 25 basis points may not be passed on to the customers by the commercial bank. Do I then understand that commercial banks can and will do whatever they think is relevant for them namely they may decide

Not to pass on the benefits to the consumer.
Pass on partial benefits or
Pass on full benefits.

Prof: Honestly, what you state is true and I am equally non-plussed. For example, between September 2013 and now the RBI increased the repo rate by 75 basis points but the lending rates of banks did not move up during this period. On the contrary, the weighted lending average rate actually fell by 20 basis points between September 2013 and September 2014. This means that is not because of RBI’s repo rate increase, the economy stalled. The commercial banks had its own agenda for fixing its lending rates.

Student: Does this happen often or is it a rare incident?

Prof.: This has happened before. Between September 2008 and September 2009 the RBI slashed the repo rate by 425 basis points but the commercial banks cut its lending rate only by 120 basis points. Similarly on another occasion namely between March 2012 and June 2013 while the repo rate fell by 125 basis points only 40 basis points was passed on to the consumer.

Student: Who determines the lending rate to the customers?

Prof.: In India, each bank fixes its own base lending rate and this is determined by a host of factors such as the cost of funds, administrative costs, profitability, etc.

Student: Are you then saying that repo rate adjustments mean nothing to commercial banks?

Prof.: I am not saying that. You see the commercial banks source only 1 percent of their total deposits from the repo window. You see the problems of commercial banks vary. Many of them carry huge non-performing assets and restructured loans. The may decide not to pass on the lower repo rate to its customers. Instead they may use the lower rate to improve their profit margin.

Student: This is unfair. As a customer to the bank and as a citizen of India, I feel I should be able to enjoy the benefits given by RBI.

Prof.: Your anger is understandable. The Indian banking system is currently in a deep mess. According to a recent news nearly 10 percent of all the lendable funds with the bank are either non performing or restructured. The banks concerned must increase their profits to pay for these non-performing assets. But for them, the interest on the fixed deposit rates would at least be higher by 1 percent. In India, the bank deposit rates are much lower than the inflation rate. Therefore it makes no sense to put the surplus money in the bank. As an individual you can choose to invest in real assets, gold and a little in the stock market.

Student: I understand you well, when you say that you should be a borrower rather than a depositor in the bank. Thank you Professor.

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