Repo-link effect: Banks likely to raise risk spread, say analysts

Analysts are not enthused about banks migrating to an external benchmark-linked lending system. They say banks will have to hike their fees and possibly tweak spreads to maintain their profitability.

While the new system will be readily available for fresh retail loans, banks will not want to shift their legacy loans to the new system. 

Even as a customer insists, the benefit could be marginal, if at all, given that banks won’t change their elevated cost structure for three years as allowed by the Reserve Bank of India (RBI), but will instead reset interest rates every three months as mandated. This poses a new risk as the repo rate is already the lowest in almost a decade. 

“Though we expect further cut in the repo rate in the upcoming monetary policy announcement, the extent of the incremental reduction is likely to be limited, given the policy rate is already at its lowest in the last decade. Hence, from borrowers’ perspective, the likelihood of rate hikes over the medium term appears to be higher than rate cuts,” said Anil Gupta, vice-president (financial sector ratings), ICRA.  

The external benchmarks offered by the RBI are repo, three months and six months’ treasury rate, and any rate set by the benchmark setting authority Financial Benchmarks India (FBIL).  

Private sector bankers have earlier warned that repo is inherently a volatile rate, but linking the lending rates to the short-term treasury bills would be even more volatile.

What happens when there is a sudden liquidity crisis and rates shoot up — “does that mean a mortgage borrower will overnight pay 200 basis points higher rate?” asks Suresh Ganapathy, analyst at Macquarie Capital Securities.

The main issue here is that the deposits are not floating in nature, but the RBI has made it mandatory for the loans to be floating. This would likely give rise to stark asset-liability mismatches in banks’ books that might become quite apparent few years down the line, analysts say. “If an implementation is forced, this could create a structural issue in managing NIMs (net interest margin) for banks,” Ganapathy said. 

The new set of lending rules, however, affects only retail and small and medium enterprises floating rate loans, and the products affected are largely only mortgages. Other fixed retail loans, such as credit cards and personal, education, and vehicle loans, won’t come under the new rule.

Barclays’ chief India economist Rahul Bajoria wrote in his report that lack of shift in deposit costs may cause banks “to not aggressively pursue external benchmarking of legacy loans”, while the lenders may choose “to charge a high administrative fee to reorient loan structures, thus, potentially offsetting the benefit of the new structure”. Banks will also likely increase their spreads to protect their margins, Bajoria said.

ICICI Securities said banks with larger proportion of floating rate retail and MSE loans are likely to be impacted, with the housing loans segment to be particularly hit hard as they are floating rate and have no prepayment charges. 

 “Axis Bank, SBI, which have significant housing portfolio and existing book conversion, can impact margins. This will lead to overall pressure on margins for banks with high retail floating loans. Kotak Mahindra Bank, IndusInd Bank, and HDFC Bank have higher non-housing retail portfolio, where floating proportion will be lower,” ICICI Securities wrote.

Banks may link saving and bulk term deposit (Rs 2 crore and above) products with external benchmark to address pressure on margins. However, housing finance companies would be impacted more as they will have to match their books under competitive pressure. “Their costs will not be declining in line with loan rates and thereby margins can be in pressure for both LIC housing finance (retail loans-93 per cent) and HDFC (71 per cent),” the brokerage wrote.