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Have banks passed on the benefits of RBI's rate cut?

Last updated on: June 11, 2019 12:24 IST

In the last three years, public sector banks have responded to the RBI’s policy rates more strongly than private banks.

The Reserve Bank of India cut the policy repo rate to 5.75 per cent last week, and changed its policy stance to “accommodative,” meaning that a rate hike is off the table.

The previous year FY19 saw growth falling and subdued inflation.

 

The RBI responded with a gradual tightening of the monetary policy in the first three quarters, when oil prices were rising.

It then resorted to monetary easing - three reduction in policy rates in a row (Chart 1).

The RBI hopes that this would provide the much-needed boost to aggregate demand and private investment, and bring growth back on track.

But all depends on effective monetary transmission, as the monetary policy committee underlined.

The MPC said that a reduction of 50 bps in the policy rate resulted in a reduction of 21 bps in the weighted average lending rate (WALR, hereafter referred to as lending rate) on fresh loans so far, but an increase of only 4 bps on past loans.

This reveals inefficient monetary transmission.

The marginal cost of lending rate (MCLR) acts as an external benchmark for banks’ lending rates.

In the last three years, public sector banks (PSBs) have responded to the RBI’s policy rates more strongly than private banks (PvSBs), shows Chart 2A.

A reduction of 0.5 percentage points (pp) in the policy rate resulted in a reduction of 0.82 pp in the MCLR for PSBs, and a reduction of 0.35 pp in MCLR for PvSBs.

Banks apply a spread over the MCLR to derive the lending rate, and it varies across sectors. In the last four years, the policy rate dropped 1.5 pp, and a comparable drop in lending rates on outstanding as well as fresh loans followed (Chart 3A).

However, banks’ lending rates followed the RBI’s policy rates disproportionately in different periods, showing the impact of external factors.

While full monetary transmission did not happen in the period up to demonetisation, surplus liquidity reduced lending rates faster than policy change in the post-demonetisation period.

But in the most recent six months, a 0.5 pp of reduction in the policy rate has not yet brought any substantial change in lending rates, shows Chart 3B.

Even after the rate reduction and scope for subsequent easing, the RBI slashed its growth projection for FY20 from 7.2 per cent to 7.0 per cent.

Photograph: Danish Siddiqui/reuters

Abhishek Waghmare
Source: source
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