Will Banks Cut Interest Rates Now?

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Recently, the government cut deposit rates on small savings scheme including Public Provident Fund (PPF), Kisan Vikas Patra (KVP) and senior citizen deposit.

To take note, it cut interest rate on PPF scheme to 8.1% for the period 1 April to 30 June. This was from 8.7% earlier. On one-year post office deposit scheme, it reduced interest rates to 7.1% from existing 8.4%. Similarly, the interest rate on KVP has been reduced to 7.8% from 8.7% earlier. Senior citizen savings scheme of five years would now earn 8.6% interest compared with 9.3% earlier.

These moves by the government were done for two specific reasons-

1. To bring down the cost of funds on money deposited at banks
2. Inducing banks to reduce their interest rates on money advanced as loans

While this has signaled banks to reduce their rates, the question is will this happen>? From past experience, the answer can be a clear 'NO'.

As an article in Livemint states that although the government has slashed small savings deposit rates, bankers say they will decide on reducing interest rate on deposits and advances only after the RBI monetary policy early next month.

The RBI's first monetary policy statement for the financial year 2016-2017 is scheduled to be released tomorrow. And the consensus in the market is that the RBI will reduce the rates by 0.25% to 0.50%.

Assuming that the RBI does reduce the interest rates, will the banks follow suit? The past experience shows that the direct correlation between RBI cutting the repo rate and banks passing on that cut at the same rate in the form of lower lending rates is rather weak.

As RBI governor Raghuram Rajan stated, "Since the rate reduction cycle that commenced in January [2015], less than half of the cumulative policy repo rate reduction of 125 basis points has been transmitted by banks. The median base lending rate has declined only by 60 basis points."

The reason why banks are not willing to cut their lending rates is because it will reduce their income from interest earned. Further, the concern is that public sector banks (PSUs) are staring at a huge problem of corporate bad loans. And in order to handle this, banks are hoping to make a greater profit by cutting their deposit rates, but not cutting their lending rates at the same pace.

So, by looking at the above practicalities, we believe that the chances of banks cutting lending rates are limited.

However, the scope and pace of interest rate cuts by banks will be influenced by the decision that the RBI will take in its monetary policy tomorrow.

While the market seems to be expecting a 25 basis points rate cut, Ajit Dayal, in a recent article in The Honest Truth, challenged the consensus. He thinks a 1% rate cut is possible.

But that's just a part of the picture. In his latest Diary entry, Vivek Kaul has argued that the RBI should not cut the repo rate by 1%, or at least not all at once. His reasons are sound - the strongest being that banks have not passed the cut in deposit rates to the lenders and that the entire situation needs to be viewed from the point of view of savers. For more about Vivek's views on interest rates, click here.

Who do you think is right - Ajit or Vivek? To vote your opinion, please click here.

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