2020-07-12 22:23:00

Since January 2019, the Reserve Bank of India (RBI) has been trying to drive down interest rates of banks but has not been very successful in doing so. Nevertheless, in the last few months, the negative economic impact of covid-19 has achieved what RBI could not. Mint takes a look.

What is behind RBI’s move to cut repo rates?

Between January 2019 and February 2020, RBI cut the repo rate, or the interest rate at which it lends to banks, by 135 basis points to 5.15%. One basis point is one-hundredth of a percentage. The idea behind the move was to encourage banks to reduce interest rates on loans in the hope that at lower rates, people will borrow and spend more, and businesses will expand more by borrowing. Hence, the economy will grow faster. As a result, banks did cut lending rates, but not as fast as RBI’s repo rate cut. The weighted average lending rate on fresh loans of banks fell by 53 basis points to 9.26%.

What has happened since Feb this year?

Since February, RBI has slashed repo rate by 115 basis points to 4%. Between February-end and May-end, the weighted average lending rate on fresh loans has reduced by 72 basis points to 8.54%. Hence, lending rates have fallen faster since February, after the coronavirus outbreak. Central bank’s monetary policy could perhaps be one reason behind such a shift. Other than slashing the repo rate, RBI has also pumped more money into the financial system in various ways. However, the major reason for a fall in lending rates is something else. It is essentially due to reduced lending by banks post-covid.

Pandemic effect

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Pandemic effect

Why have rates reduced at a faster rate since Feb-end?

Between February-end and 19 June, commercial banks raised deposits worth 5.42 trillion and lent only 1.4 trillion, or around 26% of deposits. In comparison, during pre-covid times, between early January 2019 and February 2020, lenders had raised deposits worth 12.92 trillion and lent 7.67 trillion, or around 59% of the total deposits.

How does this explain a fall in lending rates?

Since the coronavirus outbreak, banks have been raising more deposits than giving loans. This has put them in a position to cut interest rates on their deposits. In the process, lenders can slash rates on loans granted as well. Interest rates on deposits are of greater importance in interest rate transmission than the repo rate. Between February-end and early July, deposit interest rates have reduced by 90 basis points on an average. This has eventually translated into lower lending rates.

What do the changes since Feb end say?

People and businesses were borrowing more one year ago when interest rates were higher than they are now. Hence, lower interest rates do not necessarily lead to higher borrowing. More than interest rates, what matters while borrowing is the confidence people and businesses have in their economic future and their ability to repay loans, which is lacking at present. It can also be seen in people saving more for a rainy day.

Vivek Kaul is the author of Bad Money.

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