With credit growing at a faster pace than deposits, exerting pressure on banks’ funding resources, deposit rates and, in turn, lending rates have continued to rise over the past two months. This is despite the RBI holding its policy rate since August and the yield on G-Secs cooling off. Hence, even as the RBI has delivered on market expectations and held its key repo rate in Wednesday’s policy, loans rates will continue to rise. Also, risks to fiscal slippages, uncertainty over inflation trend and global factors can lead to hardening of interest rates in the coming months.

While the RBI has substantially lowered its inflation projection for the second half of the fiscal (from 3.9-4.5 per cent to 2.7-3.2 per cent), it has retained its calibrated tightening stance owing to possible risks from fiscal slippages, reversal of unusually low food prices and increase in non-food inflation. Hence, while RBI’s rate action may see a prolonged pause, rates hikes by the central bank cannot be altogether ruled out over the next six months.

However, the RBI mandating banks to peg new floating retail loans to external benchmarks, could improve transmission in the long run and benefit borrowers.

Credit-deposit ratio inching up

Through 2014, 2015 and up until the June quarter of 2016, credit deposit ratio had been in the 76-78 per cent range, implying that banks were able to deploy around ₹76 or ₹78 out of every ₹100 deposit as loans; the rest was parked in government securities and other investments.

Post demonetisation in November 2016, as deposit growth spiked and credit growth slipped to 5-7 per cent levels, credit deposit ratio fell to 71-73 per cent. Since December 2017 quarter though, credit-deposit ratio has been on the rise. In the December 2017, March 2018, June 2018 quarter, credit-deposit ratio was in the 75-76 per cent range. As of September quarter end and latest available data (as of November end), the ratio has moved up to 76-77 per cent levels.

This implies pressure on banks’ resources as loan growth has now inched up to 14-15 per cent levels, while deposit growth is much lower at 9-odd per cent. Banks have hence been hiking deposit rates to garner higher share of deposits, which has in turn prompted them to increase lending rates to protect margins.

Deposit rates had gone up by 25-50 basis points on an average (even as high as 90-100 bps in some cases) since January, until the previous policy in October. Banks’ benchmark lending rate—one-year MCLR—too went up by 25-35 bps on an average, to as high as 60-70 bps in a few banks during that period.

Despite the RBI holding rates in its October policy, deposit rates have continued to inch up by 15-25bps over the past two months. A few banks such as Bank of Baroda, Bank of India, Canara Bank, PNB, SBI, Axis Bank and HDFC Bank have increased their one-year MCLR by 5-10 bps since October. ICICI Bank has increased its MCLR by about 25 bps since October.

PSU banks vs private banks

Interestingly, there is a mismatch in the credit and deposit growth trend among private and public sector banks. The deposit growth for PSU banks has been in the 4-5 per cent range over the past six months. Credit growth too has been modest at about 4 per cent in the latest September quarter. For private sector banks, on the other hand, credit growth has been healthy at 14-15 per cent against a lower 8-odd per cent deposit growth in the September quarter. Hence, private banks have been increasing deposit rates more aggressively (broadly) than public sector banks to fund their credit growth. This disparity is likely to persist and lead to further deposit and lending rate hikes, by private banks in particular.

Also, given that the risk perception in the system has turned adverse after the IL&FS crisis, banks will price some of this into lending rates—in particular for lower rated corporates. The spread between G-Sec and corporate bond yields (AAA rated and AA) has widened by 30-40 bps over the past three months, indicative of the higher risk perception.

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