The Reserve Bank of India (RBI) has pressed the 'pause' button for any further cuts in the repo rate in its latest policy review. The repo rate is rate at which banks borrow short term funds from the RBI. But this doesn't mean banks won't reduce interest rates.
The calculation of interest rates on loan is based on the cost of savings and current account deposits, which is 40-50 per cent of total deposits.
Similarly, there are bulk and fixed deposits where the cost differs. The banks borrow from the RBI's repo window at 6.25 per cent to meet any shortfall of funds. The final interest charged to borrower covers the interest cost, administrative or operational expenses and margin of profit including risk element.
Given the various element of costs, you can still expect banks to reduce interest rates on home, car and other retail loans. Here is why.
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Banks Flooded With Deposits
The banks are flooded with current account and savings deposits post the demonetisation of high value currencies. There are expectation of 20-30 per cent of these deposits staying back with the banks. In fact, this sudden spurt in deposits have reduce the banks' reliance on high cost deposits like bulk deposits and fixed deposits. Most of the banks have already reduced their interest rates on bulk and fixed deposits. This has a direct positive impact on the overall cost of deposits in terms of cost going down. So, the banks will be able to reduce interest rates.
Slow and Gradual Transmission of Policy Rates
The banks are always slow in transmitting the cuts in repo rate or the policy rate in the actual lending rates. As per the minutes of the last policy meet, the actual transmission of 175 basis points cut in the policy rates since January 2015 has been around 50 basis points. Though some have reduce interest rates post demonetisation but that was more because of the advantage they have of sourcing deposits (fixed and bulk) at lower interest rates. The full transmission is yet to take place and there is still scope for banks to reduce interest rates for borrowers.
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Competition Is A Great Motivator
At a time when corporate banking is not growing, there is a fierce competition in the consumer banking space which is growing at over 20 per cent. In fact, consumer banking has been a great saviour for the banking industry. The banks are very active in home, car, personal loans, etc. At a time when the deteriorating asset quality and higher provisioning is eating away profits and credit offtake, especially from the corporate sector, is not picking up, the competition in the consumer banking space will see banks reducing rates to corner a larger business.
Digital initiative reducing other costs
The banks price their loans based on the interest cost, administrative cost and profit margin. In the last few years , the digitisation has been helping banks to reduce costs. In fact, digitisation both at the back end and front end (digital wallets etc ) have taken a big leap. Given the volatile operating environment , many banks were a bit hesitant to transfer some of the cost benefit to borrowers, but once things improve in the economy, there will be some players reducing interest rates by taking advantage of the digitisation process.
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