The repo linked lending rates mandated by the Reserve Bank of India (RBI) for home, auto and other loans have been cheered by one and all, but are we ready for repo linked deposit rates on our savings? Probably not. There is a vast population which puts their hard earned money in banks for better safety and liquidity. These two views don't square with each other.
The lending rates of banks on home or personal loans are actually a function of their cost of funds, overheads, risk premium and profit margin. That's the reason why you pay less for a safe mortgage (home loan) and more for an unsecured personal loan. While there is pressure on banks and RBI from both government and borrowers to transmit the repo rate cuts to final borrowers, the benefit of linking repo to lending rates won't be available to the majority of existing borrowers unless they switch their loan to new benchmark rate. In fact, even if they switch, the rates would subsequently jump faster when the interest rate cycle takes an upturn. Take for instance, existing borrowers of home loans who haven't got an advantage of current lower interest rate despite almost 110 basis points cut in the repo rate. This policy rate is the rate at which banks borrows funds from RBI for their temporary mismatches.
The solution, every banker knows, lies on the liabilities sides. Liabilities (deposits) are locked in a fixed rate while assets (home or auto) now would be at floating rate. In fact, the entire deposit liability of banks, currently at Rs 145 lakh crore, is locked at a fixed rate. The deposit rates in the banking system are not coming down as fast as fall in the repo rate because of competitive pressure. There are new banks which are offering far higher rate to build the deposit base. In addition, there is also competition from postal savings rates, which are higher than bank deposit rates.
Ideally, the RBI should nudge the banks to first link their savings rates to repo rate. Currently, SBI has taken a lead in linking its savings rate as repo rate minus 2.75 per cent. But this is only for deposits of over Rs 1 lakh. These higher deposits constitute about 10 per cent for India's largest bank. So, all banks have to follow suit. In addition, the repo linked deposit rate should percolate down to retail deposits.
For banks, the low cost current and savings accounts (CASA) matters a lot. Higher the CASA, better it is to play the interest rate game in the market as there is a flexibility to earn higher margin and reduce rates below competitors to write more business. Public sector banks used to enjoy a CASA of 40-50 per cent but now private banks are catching up. Kotak Bank has the highest CASA of 52 per cent in the industry.
Many suggest home loan borrowers could be trapped if some aggressive bank(s) try to offer a much lower repo linked interest rate to garner new business and attract refinancing home loan customers from other banks. They would see the impact only when interest rate goes up. Ideally, they should stay with the bank with one of the highest CASA ratios and also low and stable NPA track record.
But in the longer run, the solution lies in linking both the sides-deposits as well as lending (which RBI has already done) to be floating or linked to market benchmark. This is what RBI and the government should push for, which also augur well for the banks and stability of the financial system.