Will Banks Pass on the RBI Rate Cut Benefit to Borrowers?

New Delhi: When the Reserve Bank of India cuts interest rates, borrowing cost of banks goes down. This, in turn, is supposed to make loans cheaper for end customer.

In technical terms, this is called the monetary policy transmission, as banks seek to pass on the benefits of lower borrowing costs to their customers.

However, there are no formal written rules about it. The banks are not mandated by law or by any Act to follow the RBI’s rate action, which functions more as a signaling move for banks. However, Banks may not be willing to lower their borrowing costs this time round.

The bad loans problem (non performing assets) has put additional stress on banks. They now need to commit additional funds to cover for bad loans. This means that they may be loath to cut interest rates and hurt their margins.

“This time around a reduction of 25 basis points in the RBI’s repo rate may result in only a 10 basis points reduction in banks lending rates because of the huge pile of NPAs,” Bhanumurthy, an economist at the National Institute of Public Finance and Policy told News18.

“It is not clear if the Indian NPA story is over and banks will be loath to cut rates that eat into their profits,” he added. This is why the State Bank of India – the country’s largest bank – on July 31, cut the deposit rate rather than the lending rate. The bank cut rate by 0.5%, two days before the RBI’s rate cut.

Previously banks would more or less move their rates in synch with the central banks, but in those times the amount of NPAs was also less. It is currently unclear if banks will reduce rates. Which means that the RBI’s rate action today may not result in a reduction in retail loans for homes, vehicles and students.