The Reserve Bank of India cut the policy repo rate to 5.75 percent last week and changed its policy stance to “accommodative,” meaning that a hike in the rate is off the table. The previous year FY19 saw growth falling and repressed inflation. The RBI responded with a progressive tightening of the monetary policy in the first three quarters when the oil prices increased. It then resorted to monetary easing three reductions in policy rates in a row. The RBI hopes that this would provide the much-needed boost to aggregate demand and private investment, and bring growth back on track.
But it all depends on effective monetary transmission, as underlined by the monetary policy committee. The MPC said that a reduction of 50 bps in the policy rate resulted in a reduction of 21 bps in the weighted average lending rate (WALR, hereafter referred to as the lending rate) on fresh loans so far, but an increase of only 4 bps on past loans. This reveals inefficient monetary transmission. The marginal cost of lending rate functions as an external benchmark for banks’ lending rates.
In the last few years, public sector banks (PSBs) have responded to the RBI’s policy rates more actively than the private banks (PvSBs). A decrease of 0.5 percentage points (pp) in the policy rate resulted in a reduction of 0.82 pp in the MCLR for PSBs, and a reduction of 0.35 pp in MCLR for PvSBs. Banks apply a spread over the MCLR to acquire the lending rate, and it varies across sectors. In the last few years, the policy rate decreased 1.5 pp, and a comparable drop in lending rates on outstanding as well as fresh loans followed. However, banks’ lending rates followed the RBI’s policy rates irregularly in different periods, showing the impact of external factors.
While full monetary transference did not happen in the period up to demonetization, surplus liquidity reduced lending rates faster than policy change in the post-demonetization period. But in the most recent six months, a 0.5 pp of a drop in the policy rate has not yet brought any considerable change in lending rates, shows. With the current rate cut, the Reserve Bank Of India (RBI) has reduced 110 bps so far this year. Due to the massive rate cut this year, banks will be expected to pass on the rate cut by lowering their lending rates possibly reducing the equated monthly EMI instalments that individuals pay on home and consumer loans.
The RBI will also reduce the risk weight for personal loans to 100% from 125% allowing banks to lower their loan rates. Currently, the risk weight requirement for personal loans is 125 per cent. However, the relaxed requirement would not be applicable to credit cards. Risk weight refers to the capital banks keep aside as provisioning to cover any loan defaults. The RBI’s move is likely to boost consumer spending during the festive season.
Under the standardized approach for credit risk management, all unsecured consumer credit, including personal loans and credit card receivables, as both of them are unsecured lending, attract a higher risk weight of 125 per cent or higher, if warranted by an external rating of the counter-party. Further evaluation has concluded that the risk weight for consumer credit will be reduced, including personal loans, but excluding the credit card receivables, to 100%
A personal loan is an unsecured loan where you do not have to submit any kind of collateral or security to procure one, which is why personal loan interest rates are higher compared to other secured loans. Even after the rate reduction and scope for successive easing, the RBI slashed its growth projection for FY20 from 7.2 percent to 7.0 percent.
