Why rate cut will not make loans cheaper?

The RBI, in today's Monetary Policy Committee (MPC) meeting, announced a cut in the repo rates by 25 basis points. It had also announced a rate cut of similar magnitude in last MPC meeting in February 2019. However, except for a few public sector banks, the interest rate benefits were not passed on to the ultimate customers. Here are five reasons, according to various economists and bankers, on why interest rates this time as well won't benefit customers:

1. Deposits growth is already low. Any reduction in deposit rate would mean lower money being deposited into the banking system. And banks can’t afford to lose their depositors owing to the tight liquidity conditions in the market. Simple reason: Savers would not want lower yield on their savings.

2. Even if the deposit rates, say, are reduced by the banks. The effect would be seen with a lag. Reason being that only new deposits will be repriced at a lower rate. The old deposits will continue getting the earlier rate.

3. Now suppose, MCLR is also lowered. The benefit will not be transmitted to all the borrowers as the banks will be cautious of the credit quality of the clients. For example, if someone from the power sector wants the loan, the bank might altogether say no to giving credit or will lend at a higher rate. So, here the transmission is weakened.

4. Also, the banks are reluctant to lend owing to the NPA issue. They prefer lending to the retail sector than non-retail. This issue will also be an impediment in the transmission mechanism.

5. Dearth of funds: The banks have been facing the liquidity deficit since 6 months now. With elections around the corner, the availability of funds with the financial system is expected to decline further. So, the banks might not be willing to transmit the benefits of a rate cut to the consumers.

However, experts believe that the external benchmarking will at least smoothen the transmission of rate cuts.

"I believe this external benchmarking (benchmarking all retail loans with repo rate or any other benchmark interest rate) is going to smoothen the transmission process. RBI is to hold further discussions with stakeholders and work out an effective mechanism for transmission of rates," said Manisha Sachdeva, Associate Economist, Care Ratings.

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Why rate cut will not make loans cheaper?

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