The largely favourable reactions to the larger than anticipated interest rate cut by the RBI last Tuesday was expected. Less obviously, has the near euphoria in the financial markets in the wake of the sharp reductions concealed the genuine concerns of depositors. Can the banking system and indeed the economy thrive ignoring depositors’ genuine concerns?
It is axiomatic that when policy rates are brought down banks will cut their deposit rates even while taking baby steps on the lending side. Monetary transmission is said to be complete if banks bring down their key lending rates to match the rate cuts. It is the government’s common refrain that transmission has not been complete in recent times. Banks have, however, expressed their inability in the face of certain inbuilt rigidities. For instance, a reduction in term deposit rates takes effect over time as investors might have parked their money in 3-year deposits.
Big banks while announcing lower base rates have indicated a reduction in their deposit interest rates across different maturities. State Bank of India, for instance, has said that there will be a 0.25 percentage point reduction in fixed deposit interest rates over all tenures.
The bank was the first to reduce its base lending rate after the policy announcement. Its key lending rate is now lower by 40 basis points (0.40 percentage point). In days to come other banks will cut their lending rates aggressively. Obviously they will have to make up by lowering their deposit rates to protect their ‘spread’ — the difference between borrowing (mostly deposits) and lending rates.
Bank profitability and depositors’ interestIt is this that has determined a bank’s profitability although banks have been concentrating on augmenting their non -interest income such as forex earnings, letters of credit and so on. But in a scenario of falling lending rates it is the depositors who bear the brunt.
Over the past few weeks the Financial Scene has voiced the genuine concerns of depositors especially those who are dependent on deposit interest income for their survival. The very large responses we have been receiving unfortunately cannot be accommodated. Many of them transcend the subject of bank deposits and cover the entire gamut of senior citizens and their problems. Looking beyond monetary policy it is clear that fiscal policy (the union budget) will address some of these concerns.
Turning to the policy announcement, the 50 basis point repo rate cut has created such an impact because it indicates a sharp reversal of the RBI’s stance on the inflation-growth dynamics. On many occasions the RBI Governor has pointed out the “upside” risks to inflation. Recent success in containing inflation is largely due to the fall in global commodity prices including that of petroleum.
Of the threats from within, the failure of the monsoons is confirmed and the RBI has put the onus of containing food inflation through judicious food management policies. The consumer price of the next few months will show an uptick but that will be attributed to statistical factors. Anyway, the RBI is confident of reaching its January 2016 inflation target.
Do you understand real and nominal returns?Even granted that there were strong pressures on the RBI to cut rates, it may not be correct to say that the central bank buckled under pressure.
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