RBI signals low interest rate regime; banks begin to cut rates

The move by the Reserve Bank of India (RBI) to cut policy rates in a surprise move on Thursday morning has caught most banks and customers completely off guard, despite a growing chorus for reducing the interest burden. While some banks such as Union Bank of India and United Bank of India quickly announced a cut in their base rates to make loans cheaper for individuals and companies, for most others, it is "just a matter of time" before joining the band.

What is making everyone happy is that this marks the departure in RBI's policy stand. After 19 months of continuously hiking rates or keeping status quo, it is the beginning of the rate easing cycle. Bankers and economists say that more such cuts may be on the way.

Home loans and auto loans are all set to get cheaper with this rate cut, a major signal to a lower interest rate regime in India. Indeed, this is going to spur the growth in the economy and beef up consumer spending.

By afternoon, United Bank of India was the first to announce the cut in their base rate by 25 basis points to 10%. Towards evening, Union Bank of India picked up the cues and reduced the base rate by 25 bps to 10% with effect from January 27. The bank has also reduced interest rate on deposits in various buckets under retail and bulk deposits from 10 bps to 50 bps.

Arundhati Bhattacharya, chairman and managing director, State Bank of India, told dna, "SBI asset-liability committee (ALCO), the apex body of the bank that will take a call on interest rates, is meeting tomorrow."  MS Raghavan, chairman and managing director, IDBI Bank, told dna, "You can expect the bank to reduce its base rate in a day or two. But we are yet to decide on the quantum of reduction."

The move to cut the rate at which it lends money to banks (called repo rate in banking parlance) by 25 basis points (one basis point is equivalent to one-hundredth of a percentage), is an important signal to point which way the rates are headed, but the transmission may be less than perfect because of high bad loans and restructured loans of the banking sector. But the key to lower bank lending rates would be the government's ability to revive stalled projects.

The dilemma for most bankers is to do a balancing act between the net interest margins (NIMs) and their ability make credit attractive at cheaper rates of interest. If the bankers have the confidence that investment climate will improve and quality demand for credit will pick up, they will be encouraged to pass on the rate cuts.

Bankers believe that more rate easing may be on the offing as inflation is getting entrenched at lower levels and oil prices unlikely to rise sharply. Chanda Kochhar, managing director and chief executive officer, ICICI Bank, said, "The rate cut by RBI was widely anticipated and is a welcome move. Together with the various initiatives being taken by the government, the rate cut would strengthen the positive momentum in the economy by lowering borrowing costs as the lower rate regime reflects in bank funding costs over time. We need to continue to address the issues impeding output and investment in key sectors to leverage this momentum for growth."

Some bankers, however, want to be certain what will be the impact on their margins if they reduce the base rate. With all the loans are linked to their base rate, the cut in the base rate will move down the lending rates of all their advances adversely impacting their margins.

CVR Rajendran, chairman and managing director, Andhra Bank, said, "If all my competitors are reducing, I will also reduce rates. Otherwise I foresee a cut in lending rates only towards the end of the quarter. Andhra Bank will be cutting deposit rates by 25 basis points for the one year deposits."

Most banks have been cutting deposit rates for some time, making room for a cut in the lending rate.