By Prashansa Srivastava
On the first day of the year, the State Bank of India (SBI) announced a sharp decline in lending rates for old customers whose loans were linked to base rates. The bank decreased its base and prime lending rates for existing customers by 30 basis points each. The country’s largest lender will also extend its on-going waiver on home loan processing fees until March 31 for new customers and for customers switching their loans from other banks to SBI.
The base rate is the minimum rate established by the Reserve Bank of India, below which the banks cannot lend to customers. It helps to enhance transparency in the credit market and ensures that banks pass on the lower cost of funds to their customers. SBI’s rate is now the lowest among the major lenders. The revised base rate for the bank is now 8.65%, while the Benchmark Prime Lending Rate (BPLR) is 13.40%. The BPLR is the rate at which commercial banks charge their most creditworthy customers. However, the bank has not made any changes to its current benchmark, which is the marginal cost of lending rate (MCLR)
SBI’s move to cut the base rate comes just after a recommendation, from a committee set up by the Reserve Bank of India (RBI), to link bank lending rates to a market benchmark in a bid to hasten monetary policy transmission. Monetary policy transmission is the process by which the central bank’s monetary policies are passed on through the banking system and how they ultimately influence general economic activities such as consumption and investment.
Implications of the rate changes
About 80 lakh customers will benefit from the new rates, according to PK Gupta, managing director for SBI. The biggest beneficiaries will be those borrowers who had taken out floating-rate loans, including home loans, before April 2016, and are still on the old pricing regime. With the new rate reductions, older borrowers will have no incentive to refinance their loans from other borrowers.
A significant section of SBI’s long-term retail borrowers, in particular, students and home loan borrowers, have their lending rates linked to the base rate and will thus benefit the most from the move. The other half of retail borrowers have migrated to a marginal cost of lending rate (MCLR) with which the lending rates are locked for a term of one year and are revised at the end of each successive year. Currently, SBI’s MCLR is in the range of 7.70-8.10%.
Since consumption and investment are often financed on bank credit, a decrease in interest rates encourages increased consumption and investment by both businesses and households. Cheaper credit gives the economy a boost in times of slow economic growth and can prevent a recession.
RBI rate cuts
With the SBI cutting its base rate, it is passing on the rate cut from the RBI to the masses. Normally, when the RBI cuts its repo rate—the rate at which it lends to banks—very few banks pass it on. This lack of interest rate transmission is at the centre of an important debate in economics over the efficacy of RBI rate cuts in stimulating the economy.
Recently, in spite of the cut in the policy rate by RBI, the cost of funds has not come down which is why most banks are not able to transmit the rate cuts to their customers. A large number of bad loans held by the banks are also discouraging them from cutting rates. When faced with a rate cut by the central bank, private banks find that decreasing deposit rates is an easier way to increase their profit margins than reducing loan rates.
However, if one bank—such as the SBI—follows the RBI by cutting rates, other banks will follow suit. This will strengthen the impact of the RBI’s monetary policy. Thus the recent rate cut will be beneficial to the economy as a whole by overcoming the failure of private banks hitherto to pass on RBI rate cuts.
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