Banks quick to hike interest on loans, not deposits

Between May and August, the average interest rate on fresh rupee loans increased by 47 bps, and the same for outstanding loans rose by 34 bps. However, the increase in deposit rates failed to match this pace. The rate on outstanding term deposits grew only 22 bps during this period.

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The loan and deposit rates are based on weighted averages of all scheduled banks. The data for September will be updated by RBI later this month. Foreign banks were the most aggressive in making their loans costlier, with 69 bps and 111 bps increase on outstanding and fresh loans, respectively.

In August, when RBI raised the repo rate by 50 bps, the average lending rate for outstanding loans of scheduled commercial banks rose by 14 bps to 9.13%, while the median marginal cost of funds-based lending rate (MCLR) moved up 10 bps. Yet, it had no discernible impact on average deposit rates, which rose just 7 bps to 5.29% in August.

Loans linked to external benchmark-linked lending rate (EBLR) are likely to get repriced faster with the change in the policy rate. “Repricing of the entire term deposit would take time, as key banks’ deposits have an average duration of nearly two years,” said a recent Systematix Institutional Equities report. “For most banks, the repo rate is the benchmark for EBLR-based loans, while term deposit rates are more dependent on the liquidity position and three-year G-Sec yield movements,” it added. Both MCLR- and EBLR-linked loans have over 40% share in total outstanding floating rate rupee loans.

Historical evidence, too, points towards a sluggish transmission of deposit interest rates in some instances. By the time a 50-bps rate hike cycle ended in August 2018, domestic term deposit rates had increased by 7 bps since the end of the preceding cycle, while lending rates on fresh loans had risen by 10 bps.

Despite the current rate hike cycle, interest rates are still below pre-covid levels. Compared to the end of the last rate cut cycle till May 2020, fresh loan rates and outstanding loan rates are down 17 bps and 63 bps, respectively, but deposit rates are down much more: 83 bps.

Even in down-cycles, deposit rates do not react with similar alacrity as loan rates. For instance, between February 2019 and May 2020, when there was a cumulative decline of 250 bps in repo rate, deposit rates fell by 64 bps, while lending rates on fresh loans and outstanding loans declined by 113 bps and 59 bps, respectively. During the rate-cut cycle of 200 bps from January 2015 to August 2017, deposit rates fell sharply by 207 bps, while lending rates on outstanding loans declined by 155 bps.

Meanwhile, rising credit demand is also expected to push deposit rates. “Banks have already increased their MCLR and deposit rates. Further, they are likely to increase deposit rates due to declining liquidity in the market, upcoming festival season, elevated inflation and widening credit deposit growth rate,” said a recent CareEdge report.