Wednesday, 8 April 2015

Effect of RBI Rate Cut on Indian Banks in the Short Term

After the recent rate cut of 25 basis points (bps) by the Reserve Bank of India (RBI), banks may find it difficult to cut their lending rates over the short term, according to Pradeep Kumar, Managing Director of the State Bank of India (SBI).

The rate cuts from RBI were initiated after a prolonged period of inflation control by the apex bank. Going ahead in the same direction, Mr Raghuram Rajan, the present Governor of RBI, may cut rates by a further 50 basis points in the current calendar year.

 According to Mr Kumar, SBI and other major banks had already anticipated such rate cuts, and accordingly reduced their deposit rates long before the rate cut was officially announced by the RBI. Also anticipating future falls in rates, customers have been shifting to fixed deposits from their savings deposits so as to ensure steady flow of interests.

In such a scenario, banks like SBI have found it difficult to get their cost of funds to decrease in spite of the lowering of deposit rates. In fact, during the last financial quarter, SBI reported a rise of 1 basis point in their cost of funds. As such, initiating rate cuts in the short term may prove difficult for banks. However, if the inflationary and rate cut trends continue, then all banking institutions will have to relook their rates.

SBI Fixed Deposit

As of now, only United Bank and Union Bank have decreased the base rates since RBI’s repo rate cut in January. The State Bank of India, however, had reduced deposit rates in July last year by around 25 to 50 bps in selected categories. There being a tilt in credit demand as well as availability of excess funds, have inspired some banks to cut deposit rates over the last two financial quarters.

The credit demand, according to Mr Kumar, hasn’t seen change in the ground level. And in absence of new policies that create new assets and large projects, there cannot be improvements in credit demand. Weak demand has also caused large banks to post flat growth figures in the corporate credit sector. ICICI bank, for instance, posted flat figures of 4% year-on-year growth in December.

Mr Kumar has also commended SBI for its system of stress recognition, which helps in identifying Non Performing Assets (NPAs) when a related event happens. SBI currently has one of the lowest restructured assets and NPAs among public sector banks in India. This indicates a high level of identification of NPAs very early in their tenures.


●     The falling rates of interest are instigating customers to move to fixed deposits from their savings deposits, thereby keeping the cost of funds constant for banking institutions. This has kept banks from reducing rates further.

●     If there are more rate cuts by RBI in future, then banks are likely to reduce their rates also.