Loans are set to become more expensive, with most banks preparing to increase their lending rates after the Reserve Bank of India (RBI) raised key policy rates for the 10th occasion in 15 months.
Banks, however, may wait till month-end before raising rates, as credit growth continues to dwindle due to the rising cost of funds. Typically, demand for bank credit remains slow in the first three months of a financial year. However, with the sharp rise in lending rates, banks fear the sluggishness may spill to the next quarter.
The central bank raised the repo rate (at which banks may borrow from RBI) by 25 basis points, to 7.5 per cent. Consequently, the reverse repo rate (at which RBI borrows from banks) was revised to 6.5 per cent to contain inflation and anchor inflationary expectations by curbing demand-side pressures.
| RATE RISES IN 2010-11 | ||||
| Date | Reverse repo (in %) | Change (in bps) | Repo (in %) | Change (in bps) |
| 20-Apr-10 | 3.75 | 25 | 5.25 | 25 |
| 2-Jul-10 | 4.00 | 25 | 5.50 | 25 |
| 27-Jul-10 | 4.50 | 50 | 5.75 | 25 |
| 16-Sep-10 | 5.00 | 50 | 6.00 | 25 |
| 2-Nov-10 | 5.25 | 25 | 6.25 | 25 |
| 16-Dec-10 | 5.25 | 0 | 6.25 | 0 |
| 25-Jan-11 | 5.50 | 25 | 6.50 | 25 |
| 17-Mar-11 | 5.75 | 25 | 6.75 | 25 |
| 3-May-11 | 6.25 | 50 | 7.25 | 50 |
| 16-Jun-11 | 6.50 | 25 | 7.50 | 25 |
| Source: RBI | ||||
Most banks are looking to increase their lending rates to ease pressure on their margins, which have been squeezed because of a series of policy rate rises in the past year and a half.
“RBI's decision to increase the repo rate by 25 bps in its mid-quarter review on Thursday was on expected lines, considering the recent inflation data release for May was at nine per cent. This measure and the prevailing systemic liquidity conditions could lead to an increase in funding costs for banks and in lending rates,” said Chanda Kochhar, managing director and chief executive of ICICI Bank.
Similar views were echoed by chief executives of both other private sector banks and state-run ones, who felt it was necessary to raise rates to prevent further erosion in margins.
“Today's rate hike signals that inflationary threats to growth cannot be ignored. Banks are more likely to transmit the hike to borrowers, as their interest spread is already strained,” said M Narendra, chairman and managing director (CMD) of Indian Overseas Bank.
However, with credit growth moderating because of the sharp rise in cost of funds, some banks prefer to wait a bit. “Rate hikes will depend on liquidity conditions. If liquidity remains tight, we will have to increase our lending rates. At present, credit growth is showing some signs of moderation. We will wait for some time to assess the situation,” said MD Mallya, the CMD of Bank of Baroda.
Bank credit grew by 21 per cent over the year in the fortnight to June 3, compared with 22 per cent growth in the previous fortnight.
“The policy rate hike will put an upward pressure on lending rates of banks. Loans to rate-sensitive sectors may moderate because of this,” said Alok Misra, the CMD of Bank of India.
With deposit growth accelerating, banks don’t foresee any immediate rise in deposit rates across maturities. Bank deposits grew 18.2 per cent annually in the fortnight to June 3, higher than 17.37 per cent in the previous fortnight.
