Banks May Not Cut Down Lending Rates

By | May 18, 2012

With the central bank of the country, the Reserve Bank of India making all provisions to slash their interest rates, its quick fire rate cuts have only been communicated and transmitted in a partial manner to the economy, much to the joy of investors of fixed deposits across the country. However, with the RBI asking investors to watch out for further cuts in interest rates in the future, there have been no cuts in their lending rates to customers as such. Banks have shown major cuts in their Cash Reserve Ratio or CRR and the repo rate by a lot of basis points. However, the decline in deposit rates has been quite meager and investors aren’t satisfied with this move. The Cash Reserve Ratio of banks, ie, the percentage of money that banks are required to maintain with the Reserve Bank of India was seen to fall sharply this year. On the other hand, its repo rate, ie, the rate at which banks borrow funds from the Reserve Bank of India had also seen a sharp decline this year.

Important nationalized banks of the country have, in a disappointed manner, reduced their benchmark lending rates by quite a small margin when compared to its CRR and repo rates. And other banks have been quick in following suit. The Reserve Bank of India has tried its best to come to a consensus with banks asking them if there was any possibility to reduce their lending rates further. However, banks clarified their stand by stating that a large percentage of their funds had been disbursed at interest rates that were far below their benchmark. Since a lot of borrowers were benefited, and continue to benefit from such low interest rates, there was no urgent need to reduce their rates of interest. Many low-income people from the rural class like farmers were given a wide variety of loans like home loans, and automobile loans at rates much lower than the Prime Lending Rate or PLR. This facility was not just restricted to people from low-income groups. Top-rated corporate and high-net worth individuals were also allowed to obtain loans below the said Prime Lending Rates, far below the benchmark rates.

The major causes behind this increased restriction by banks can be attributed to factors like slowdown in the demand for credit, hike in the risk involved in credit and rise in the expectations for an increase in the demand for non-performing loans. As a result banks have been conservative in their approach, further diluting the transmission of policies. Banks have also been taking a lot of risk on themselves owing to their level of risk aversion. This can be measured with their difference in the reverse repo rate and their Prime Lending Rates. The Reverse repo rates refer to the risk-free rate under which banks bank all their surplus funds with the Reserve Bank of India. As the gap or difference between the reverse repo rate and the Prime Lending Rate or PLR increases, greater opportunities in the cost of holding money also increase. In the last few years, there was a lot of growth in bank credit and its related opportunities, especially when there was a rise in the difference or gap between the Prime Lending Rates and reverse repo rates. Now, this gap has established itself at an all-time high, making subtle suggestions towards huge disincentives to hold more money. However, banks continue to maintain remain averse in the matters of lending. As customers, do not expect lending rates to further reduce as banks are adamant in their stance that interest rates are already quite low and no decline in interest rates should be expected in the near future.

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