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SBI bites the bullet: Will other banks also link interest rates to RBI repo rate?

Sandeep Soni
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India’s largest lender State Bank of India made a historic decision on Friday to link interest rates on savings deposits above Rs 1 lakh and short-term loans to Reserve Bank of India’s repo rate, a move that could force other lenders to follow suit. Other leading banks such as HDFC Bank, ICICI Bank, Punjab National Bank, Axis Bank, Bank of Baroda, Yes Bank, and Bank of India are expected to take a call on this soon.

However, economists believe that small banks might not have the flexibility in doing so unlike large-sized banks like SBI that have the business volume and profitability. “For small banks, the constraints are in terms of their operations and profitability and hence this transmission will not be very quick and effective. There are many other calculations that would go for them,” Charan Singh, CEO, EGROW Foundation told Financial Express Online. Singh is also the former RBI chair professor of economics at IIM Bangalore.

The new rates will be effective May 1, SBI said in a statement. The move, which is first-of-its-kind, is likely to speed up the interest rate transmission process.

Savings deposits with over Rs 1 lakh balance will be linked to the effective rate of 3.50 per cent per annum – 2.75 per cent below the prevailing repo rate of 6.25 per cent, the bank said.

SBI also said that cash credit accounts and overdrafts above Rs 1 lakh will be linked to 2.25 per cent in addition to the existing repo rate of 6.25 per cent. This means the floor rate would be 8.50 per cent. The risk premium over and above 8.50 per cent would depend on borrower’s risk profile, as is the current practice, SBI said.

“Right now the deposit growth is slowing down and obviously there is a competition for deposits to the extent that it finances loans. I am not sure how this will going to play out because when there is competition for deposits then banks entice by offering high interest rates on deposits. So we have to see how other banks may follow suit,” Renu Kohli, an independent economist told Financial Express Online.

In order to insulate small deposit holders and small borrowers from the movement of external benchmarks, SBI has decided to exempt savings bank account holders with balances up to Rs 1 lakh and borrowers with CC/ OD limits up to Rs 1 lakh from linkage to the repo rate, the bank said.

Singh said that it was high time that the RBI impressed upon the commercial banks for this because for a long time, they were not transmitting the interest rate reduction at all. “The reason they gave was that their deposit rates are not that flexible and that they have not taken deposits on flexible rates. I think it was high time that the RBI impressed upon the commercial banks for this because when the RBI reduces the repo rate, that means it wants the lending to increase. If banks don t let the lending to increase then the whole purpose is defeated,” said Singh.

In its December 2018, the RBI had proposed banks to link all fresh floating-rate retail loans and loans to micro and small enterprises to an external benchmark like repo rate or treasury bill s rate, from April 1, 2019 onward.