With the latest rate cut on 4 October, the RBI/MPC has announced the fifth rate cut in this cycle by a cumulative 135 basis points. One bps is one-hundredth of a percentage point. But, this exercise hardly means anything for the borrower who pays EMIs on home and auto loans or for small industries looking at bank lending for their business needs. Let's try to understand why.
Despite the 135 basis points cut in repo rate, at which the Reserve Bank of India (RBI) lends short-term funds to banks, banks have lowered lending rates only 30-40 bps to their borrowers. This hardly means a reduction of a few hundred rupees in their monthly Equated Monthly Instalment (EMIs). It is an illusion that marginal cuts in lending rates or shift to an external benchmark would ease the EMI burden of borrowers in a significant manner.
Take this example. A back of the envelope calculation shows that, at a rate of 9 percent interest, the EMI for a Rs 20 lakh loan taken for 20 years tenure stands at Rs 17,995. If the rate is reduced by 25 bps to 8.75 percent, the EMI comes down to Rs 17,674, a difference of just Rs 321. Currently, banks charge a home loan borrower an average of 9 percent. A 30-40 bps reduction in lending rates means that EMIs will come down by Rs 400-Rs 500. This is hardly an incentive for anyone to take a new loan or an existing borrower to rejoice on his lower interest rate burden. Why aren't banks cutting rates? The answer is simple. If banks get lower returns on loans, their Net Interest Margins (NIMs) come under pressure.
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 rates whenever the RBI has upped policy rates. If banks were willing to settle for lower NIMs, a fall in lending rates would have been much sharper. At present, at least nine banks among the large-sized lenders have NIMs above 3 percent and there are three others with above 2.5 percent.
Kotak Mahindra Bank has the highest NIM at 4.49 percent. SBI and ICICI Bank have their NIMs at 3.01 percent and 3.61 percent, respectively. In comparison, the average NIMs of US banks stand around 2.95 percent.
The average NIMs of Indian banks had fallen from 3 percent in 1999-2000 to 2.5 percent in 2009-10 but the bigger banks grew their NIMs aggressively thereafter. The RBI has been asking banks, rather complaining, about inadequate monetary policy transmission in the banking system but banks haven't paid any attention to it. Even the latest repo-linked loan pricing won't make much difference since banks can charge a premium above the external benchmark rate to ensure the final rate does not fall much. Thus, when banks do not participate wholeheartedly in the process of transmission, monetary policy becomes a non-event for the common man. Unless banks cut rates, monetary easing doesn't mean anything for someone who takes a home or auto loan.
Now, what about companies? As mentioned, in the current policy cycle the repo rate has come down by 135 bps. Ideally, this should have helped higher credit off-take. But, look at the data. Loan flow to medium and small-sized companies has actually shrunk in the 12 months ending August 2019 (according to data available on RBI site). Loan flow to medium-sized companies has registered a negative growth of 0.8 percent during this period while that to micro and small companies have shrunk by a negative 2.1 percent. Large companies have, however, seen a loan growth of 5.1 percent against 1.6 percent in the 12 months period before.
These are mainly top-rated companies that were anyway getting bank lending. In the five months to August 2019, loans to even large companies have shrunk by a negative 4.2 percent. For micro/small and medium companies, credit growth has shrunk by 4.4 percent and 1.8 percent respectively. Such a poor show is on account of a combination of factors. The economic slowdown has forced many companies to scale down activities. A slowing world economy has impacted even exports. The crisis at the non-banking industry and the liquidity woes of commercial banks in the aftermath of NPA cleanup has limited lenders' ability to lend aggressively.
To sum up, what RBI does in monetary policies"even a cumulative 135 bps rate cut"has hardly meant anything to the end borrowers. Unless banks pass on lower rates to the customer in a meaningful manner and demand revives in the economy, RBI policies will be mere non-events to borrowers.