Banks cut rates as Rajan exposes their flawed logic

RBI is of the view that a repo rate cut is a direct way to reduce cost of funds for banks and not CRR

GN Bureau | June 6, 2015


#interest rate   #rbi   #RBI   #raghuram rajan   #sbi   #syndicate bak   #bank of baroda   #bank of Maharashtra   #Andhra bank  


They get fat salary, benefits and more holidays while offering ordinary service. The bankers do not seem to care for the consumers and it takes no less than Reserve Bank’s governor Raghuram Rajan to tell them to cut interest rates.  Even the finance minister is angry has called for a meeting of bankers on Friday (June 12) to discuss rate cuts.

“Banks will have to cut rate” says Rajan and explained why it is possible, thus exposing the reluctance and the opacity of the banking sector in India.

After the RBI on Tuesday lowered the repo rate by 25 bps, some banks have begun cutting their base rate which dictates interest rate charged by the banks.

Syndicate Bank on Friday cut the base rate by 25 bps to 10%. The bank also lowered its Benchmark Prime Lending Rate (BPLR) from 14.50% per annum to 14.25%.

Central Bank of India had cut base rates by 30 basis points to 9.95%. Indian Bank has cut base rate by 30 bps to 9.95% effective June 8. Andhra Bank, too, has decided to cut base rate by 25 bps to 10% effective June 11.

On Tuesday, four banks had announced rate cuts. State Bank of India had reduced base rate by 15 bps to 9.70%, Allahabad Bank by 30 bps to 9.95%, Punjab & Sindh Bank and Dena Bank by 25 bps each to 10%, on Tuesday. Bank of Maharashtra had cut base rate by 25 bps to 10% few days before the policy.

At least three banks have cut their deposit rates in last few days. Axis Bank had cut deposit rates by 10 to 20 bps across tenures, Bank of Baroda by 25 bps and Oriental Bank of Commerce by 25 bps cut in last few days.

Why rates can be reduced?
Bankers have been holding back on interest rate cuts and demanding a cut in Cash Reserve Ratio (CRR) to reduce rates. But the RBI is of the view that a repo rate cut is a direct way to reduce cost of funds for banks.

“Yes, this is a question that some bankers raise occasionally, cut CRR. I think it should be recognised that CRR is primarily a monetary instrument.

“If we want to reduce the cost of capital and reduce lending rates, the more direct instrument to use is the policy rate which we have used,” Rajan said in his post-policy conference call with researchers and analysts.

Rajan said banks are slowly transmitting the benefits of interest rate cuts by RBI and over time transmission will increase as competition from the market increases.  "Banks have started playing part. Banks have started cutting rate. Overall transmission will increase with market competition. Banks will have to cut rate," he said.

The RBI cut the policy repo rate (the interest rate at which banks borrow short-term funds from the central bank) from 7.50 per cent to 7.25 per cent even as it kept the CRR unchanged at 4 per cent of banks’ deposits.  CRR is the slice of deposits that banks have to park with the RBI.

“The direct way of cutting the bank’s cost of funding is to reduce the policy rate,” Rajan said. The governor observed that a one percentage point reduction in the CRR, that is a 25 per cent reduction in where the CRR is right now, will reduce the banks’ cost of funding by about 7 to 8 basis points. However, the RBI has done a 25 basis points cut in the policy rate. One basis point is equal to one-hundredth of a percentage point.

“Over time that (cut in policy report rate) should reduce the banks’ cost of funding by 25 basis points, as their deposits and liabilities adjust. Which is more? 25 basis points policy rate (cut) or the 25 basis points cut in CRR that they are talking about?

“Clearly, it is the 25 basis points cut in the policy rate. So I do not understand this discussion of CRR that sometimes comes up,” said Rajan.

Meanwhile, finance minister Arun Jaitley is holding a meeting with the banks next Friday to explain why they were not passing on the successive rate cuts, totally 0 .75 per cent, to the borrowers.

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