More room for banks to cut lending rates: RBI

Reserve Bank of India on Tuesday cut the key rates unchanged but believes that going ahead banks still have room to reduce their rates further as it said that less than half of the cumulative policy repo rate reduction of 125 basis points has been transmitted by banks. The median base lending rate has come down only by 60 bps.

"I think if you look at one-three years deposit, banks have already cut significantly more than they have transmitted via base rate. So in that case there is room building up for the banks to transmit more," said Raghuram Rajan, Governor, RBI.

A cut in lending rate is preceded by a deposit rate cut to ensure that margins are protected and therefore the RBI believes that going ahead banks may bring down their base rate also down.

In order to ensure that the pace of transmission is faster the banking regulator is also looking at a modified base rate structure which will reflect the marginal cost of funds and ensure that the pace of transmission is quicker. "We are working with the banks on a new methodology to determine the base rate which will be on marginal cost and it should be put out sometime this week. What the marginal cost of pricing does is makes the costs flow through into lending rates faster. So the intent is that at least for a time, we will be able to make incremental loans on the marginal cost pricing while their historical or their legacy loans will be on the base rate, that is the intent," added Rajan.

In this calendar year the central bank has already cut repo rate by 125 basis points but at the same time banks have cut lending rates only by up to 60-70 basis points.

Another step that the RBI believes will help in transmission is that government is looking at making the small saving scheme interest rate, which includes Post office savings and Public Provident Fund, market linked. Banks have been reluctant to transmit the entire policy rate cut to borrowers as they want to keep their deposit rates attractive to match with those in small saving schemes, popular among masses.

The interest rate being offered by banks on a deposit for a year hovers around 7.50-8 per cent, much lower than the 8.7-9.3 per cent being offered on small saving schemes and that explains their reservation on reducing deposit rates further.