Private banks were the slowest to pass on the benefits of falling interest rates to their customers in 2019 compared to their state-run and foreign rivals, Reserve Bank of India (RBI) data showed.

The median one-year marginal cost of funds-based lending rate (MCLR) for private banks fell a meagre 12 basis points (bps) to 9.18% between January and December 2019, compared to RBI’s cumulative 135 bps cut in its key policy rate to 5.15%. Most bank loans are typically priced over the one-year MCLR, making it the most tracked rate.

Graphic by Sarvesh Kumar Sharma/Mint
Graphic by Sarvesh Kumar Sharma/Mint

In the same period, state-run banks have lowered their one-year median MCLR by 45 bps and foreign banks have cut their lending rates by 75 bps. Foreign banks have the lowest median one-year MCLR rate at 7.9% as of December. Their public counterparts are at 8.3%. For all scheduled commercial banks taken together, the one-year median rate stands at 8.3%.

The reason private banks are less eager to cut interest rates lies in their cost of funds. They pay the highest interest to their depositors. Private lenders are followed by public sector and foreign banks, respectively. While private banks paid depositors 6.91% interest in November 2019 (latest data), public sector banks paid 6.65% and foreign banks 5.38%, according to RBI data on weighted average deposit rates.

“To look at the transmission of rates by these banks, one must also look at how their cost of funds has changed over time,” said Anil Gupta, vice president and sector head of financial sector ratings at ICRA Ltd. “For public sector banks, credit growth is slow and, therefore, the need to aggressively mobilize deposits by offering a higher interest rate to deposits is little. Accordingly, the deposit rates for private sector banks remain higher.”

According to Gupta, foreign banks, however, pay depositors less than what other categories of banks do and, therefore, their lending rates are among the cheapest. “One factor behind it is foreign banks’ limited retail franchises and the presence of large deposits from multinational corporations, which keep their money in the same bank across the world. Hence, in the absence of retail depositors, the need to offer higher deposit rates to attract retail deposits is lower than other banks. These MNCs also maintain large current account deposits instead of term deposits, leading to lower cost of deposits,” added Gupta.

Since banks began pricing all fresh retail and small business loans to an external benchmark in October, the one-year median MCLR has dropped 5 bps for all categories of lenders.

The process of setting interest rates by banks is at the core of transmission and the central bank has for several years been trying to make it more transparent. This has led to the change from benchmark prime lending rate (BPLR) to base rate to MCLR and finally to external benchmark-based lending rates.

Apart from the median one-year MCLR rate, the regulator also publishes a weighted average lending rate on fresh and outstanding bank loans. Some believe that the weighted average rate should be followed more closely than the median rate.

The weighted average data on fresh loans also shows that private banks still lag their peers in transmission. While private banks lowered their rates by 48 bps in 2018, based on weighted average data, public and foreign banks lowered their rates by 56 bps and 86 bps, respectively.

“Undoubtedly, there has been a reduction in lending rates for both private and public sector banks if you look at the data on weighted average lending rate published by RBI,” said Krishnan Sitaraman, senior director at Crisil Ratings.

“However, the trend in the median lending rates of private banks as a category is somewhat different from the trend in weighted average lending rates because the reduction in the cost of funds for larger and stronger private banks has been higher. Therefore, the lending rate reduction for them has been higher as compared to some of the smaller private banks,” said Sitaraman.

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