RBI rate cut: Cheaper EMI an illusion unless banks get over their profit hunger

RBI rate cut: Cheaper EMI an illusion unless banks get over their profit hunger

Nine large Indian bans have NIMs above 3 percent while US banks’ average stands around 2.95 percent

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RBI rate cut: Cheaper EMI an illusion unless banks get over their profit hunger

At least four banks announced reduction in their base rates, or minimum lending rates, on Tuesday hours after the Reserve Bank of India (RBI) reduced the repo rate, at which it lends short-term funds to banks, by a quarter percentage point to support economy despite the threat of resurgence in inflationary pressure.

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These include State Bank of India (SBI), Punjab & Sind Bank, Allahabad Bank and Dena Bank. SBI cut its base rate by 15 basis points (bps) to 9.7 percent, while other three went for reductions by up to 30 bps. One bps is one hundredth of a percentage point.

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But one must remember that except SBI, other three lenders did not reduce their lending rates in the earlier occasions when the RBI cut rates. Some of them are doing it after a period of one to two years.

The base rates of these banks continue to be around 10 percent. In the current round, they have merely adjusted their very high rates to the market.

So far this year, the RBI has slashed the policy rate by a cumulative 75 bps in three rounds, but banks have been highly reluctant to cut their rates by obliging to a maximum of up to 30 bps cut. Why are banks not forthcoming in passing on the full benefit of the RBI rate cuts to the end-consumer — something they used to do in the past?

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The reasons bankers highlight for this are high non-performing assets (NPAs) on banks’ balance sheets, poor demand for loans and pressure on their net interest margins, or the spread between the interest earned on advances and interest expended on deposits.

There is indeed merit in the first two factors. Rising bad loans have damaged the health of bank balance sheets considerably in the recent years, especially that of the government-owned banks, which have over 90 per cent of the total bad loans of the industry (now above Rs 3 lakh crore) on their books. Banks would want to repair some part of the damage before expanding credit.

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Similarly, demand for fresh loans is yet to pick up in a major way on account of the delayed economic recovery. Fresh investments are yet to happen on the ground, hence no new projects yet, requiring money from banks. Artificially, pushing credit to those borrowers having little merit is dangerous, something banks had done some years back in order to grow their loan book. This contributed to huge NPAs.

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But, the third — the obsession with high NIMs — is something banks should do away with. Consider the following facts:

Arguably, Indian banks have the highest NIMs around the world. Despite this, banks have always been reluctant to pass on the rate reductions to the end-consumer, while they haven’t wasted time to increase the rates whenever the RBI upped the policy rates.

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If banks were willing to settle for lower NIMs, fall in lending rates would have been much sharper. At present, at least nine banks among the big-sized lenders have NIMs above 3 percent and there are three others above 2.5 percent. Kotak Mahindra Bank has the highest NIM at 4.87 percent. SBI and ICICI Bank have their NIMs at 3.16 percent and 3.57 percent, respectively.

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In comparison, the average NIMs of US banks stand around 2.95 percent. The average NIMs of Indian banks had fallen from 3 per cent in 1999-2000 to 2.5 per cent in 2009-10 but the bigger banks grew their NIMs aggressively thereafter.

In the past, the RBI has repeatedly expressed its discomfort on inadequate monetary policy transmission in the banking system. When banks do not participate wholeheartedly in the process of transmission, monetary policy becomes a non-event for the common man. Until banks do not cut rates, monetary easing doesn’t mean anything for someone who takes a home or auto loan.

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In December 2010, former RBI governor D Subbarao had vehemently criticised banks’ obsession for higher NIMs. “The efficiency gap between us and our peer group of countries is indicative of the catch-up job we have to do. There are several ways of improving efficiency,” Subbarao said then speaking at a banking conference.

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“By far the most important task is to improve operating efficiency on top of what has already been achieved by optimising operating costs, that is, non-interest expenses, including wages and salaries, transaction costs and provisioning expenses. This will enable banks to lower lending rates while preserving profitability,” Subbarao said.

The cost of funds of banks has fallen significantly this year so far on account of three rate cuts by the central banks. While many banks have promptly reduced their deposit rates, the action on the lending rates have been poor. It is true that monetary transmission happens with a lag but there is no excuse for banks for not passing on the full benefit of the RBI action to the consumer.

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It is an illusion that marginal cuts in the base rates would ease the EMI burden of borrowers in a significant manner and prompt new borrowers to buy new homes and vehicles.

Take this example. A back of the envelop calculation shows that, at a rate of 9.85 percent interest, the EMI for a Rs 20 lakh loan taken for 20 years tenure stands at Rs 19,102. If the rate is reduced by 15 bps to 9.7, the EMI comes down to Rs 18,905, a difference of just Rs 197.

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This is hardly an incentive for any one to take a new loan or an existing borrower to rejoice on his lower interest rate burden. Also, note that banks do not lend at base rate. The final rate at which the loan is given will be base rate plus a premium, which varies from bank to bank. Hence, small adjustments in rates wouldn’t make any major difference in the EMI burden of the customer.

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The irony is that the RBI itself is helpless in ensuring proper transmission of its policy signals through the banking system. This is something the RBI governor himself has admitted in the past.

Perhaps it is high time for banks to do away with their obsession for high NIMs and pass on the full benefit of lower rates to the borrower.

So far banks have been playing smart with minor adjustments on their rates and timing it well so to appease the RBI and give an illusion to the common man he is getting big benefit. Time has come to stop this.

(Kishor Kadam contributed to this story)

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