Valdar's Blog

Interest rates could fall soon, making loans cheaper and saving less attractive, following a slew of measures by the RBI on Saturday. The  central bank cut the rate at which it lends short-term funds to banks by half a percentage point and infusing an extra Rs 1,20,000 crore into the banking system.

Pressure on banks to cut rates has risen sharply in the past few days with the RBI making clear the crisis could only be resolved if banks followed up with measures to boost demand and sustain spending.

This would mean home, car and other consumer loans becoming cheaper by half a percentage point. Companies too can look forward to similarly lower lending rates. But, for depositors, the flipside of a rate cut is lower interest rates on savings.

Senior officials of public sector banks unanimously told STOI that rate cuts would follow very soon, perhaps within the week. They said they would follow through on the RBI’s move to contain the slowdown, even though they face a severe liquidity crunch because the central bank continues to suck cash worth $500 million every day in order to support the rupee. Punjab National Bank chairman KC Chakrabarty said that banks are likely to take their cue from RBI’s decision to cut rates.

On Saturday, the RBI in its mid-term review of policy announced that the repo rate — the rate at which banks can borrow short-term funds from RBI — will fall from 8% to 7.5% from November 3. This would make it easier for banks to cut interest rates for consumers.

Simultaneously, there will be a two-stage cut by November 8 of the cash reserve ratio (CRR) — the proportion of deposits banks have to maintain in cash with the RBI. It will fall from 6.5% to 5.5%.This will give banks access to an additional Rs 40,000 crore to lend.

In another liquidity infusing measure, RBI in effect brought down the statutory liquidity ratio — the proportion of deposit money that banks mandatorily have to invest in government securities — by two percentage points.

While the SLR is formally currently at 25%, various temporary relaxations that allowed banks to borrow from RBI against their holdings of government securities meant that it is effectively at 23.5%. Further relaxations announced on Saturday brought down the effective SLR to 21.5%, though the formal rate has been reduced only to 24%. 
 
The effective two percentage point cut means an addition of Rs 80,000 crore to the kitty available to banks for lending. With the CRR cut, that makes a total of Rs 120,000 crore in extra liquidity. One of the key relaxations was that banks can now borrow up to 1.5% of their deposit base from RBI to lend to mutual funds and non-banking finance companies (NBFCs) facing shortage of funds to repay their investors.

Non-deposit taking NBFCs that are deemed to be “systemically important” have also been allowed to get short-term foreign currency loans from abroad subject to their meeting certain prudential norms and getting approval from RBI.

Reacting to the RBI’s announcement, Union Bank of India chairman M V Nair pointed out that this was the second time that RBI had cut the repo rate within a fortnight. Prior to this, RBI had cut the repo rate by one percentage point to 8%. Since banks will find their cost of funds going down, he said they will pass on the benefit to the customer.