The RBI announced a host of measures today aimed at increasing liquidity in the economy.
The RBI announced a host of measures today aimed at increasing liquidity in the economy. As a consequence, individuals may see banks reducing their margins on interest rates charged on loans. However, fixed income earners should be aware that these steps may exert downward pressure on interest rates offered on fixed deposits by banks. as per some experts. However, the impact of these announcements will not be immediate and may be marginal.
Cut in Reverse Repo rate and TLRTO 2.0 may lead to banks cutting their margins
The RBI today announced a cut of 25 basis points (100 basis points/bps = 1 per cent) in the reverse repo rate to 3.75 per cent from 4 per cent earlier. Though this will not have a direct impact on the interest rates consumers have to pay on loans but banks are likely to reduce their spread/ margin to lend more to the consumers.
Reverse repo rate is the rate at which the central bank borrows money from the commercial banks or rather the amount which banks earn on their deposits with the RBI.
Pranjal Kamra, CEO, Finology says, "The cut in reverse repo rate by the RBI will force the banks to lend money elsewhere instead of lending it to the central bank. This is because it has become less attractive now to lend money to the RBI. This, in turn, is likely to make the banks reduce their spread/margin on their lending interest rates in order to lend more to the consumers and businesses."
Remember with effect from October 1, 2019, banks have linked their lending interest rate to an external benchmark. The effective interest rate on the loan is calculated as: external benchmark rate + spread (margin) + credit risk premium.
Kamra says, "Any change in any of the components of the effective interest rate will impact the interest rate charged on loans given to consumers. Further, as per the RBI's guidelines, the interest rate linked to an external benchmark has to be reviewed atleast once in three months. Therefore, if banks reduce their spread, then the interest rate on loans will become cheaper for both existing and new borrowers."
Kunal Varma, CBO and Co-Founder, MoneyTap says, "The latest TLTRO announcement from RBI aimed at injecting around Rs 50,000 crore of additional liquidity into the banking system, specifically via banks to small and and mid-sized NBFCs and MFIs is a well timed move. This will increase the availability of credit to the end borrowers, hopefully at lower or more competitive interest rates."
D.K. Srivastava, Chief Policy Advisor, EY India says, "Both banks and NBFCs have been provided with additional liquidity and the incentive to lend more aggressively. It is expected that loans offered by these banks and financial institutions will increase as a result of RBI’s liquidity and regulatory initiatives that were announced today."
Ashish Sharma, CFO - Aye Finance says, "The steps taken by the RBI today (such as TLTRO 2.0) will incentivize the Banks to lend to NBFCs, which in-turn will provide a window for NBFCs to disburse loans to the last mile consumer and MSME businesses. Subject to the creditworthiness and evaluation criteria of NBFCs, this RBI intervention will lead to higher liquidity or higher ticket sizes of loans to consumers; helping them effectively tackle the economic fallouts of this pandemic"
Srivastava says, "Liquidity enhancement measures are aimed at incentivising banks and NBFCs to increase their deployment, particularly to the MSME sector. It does so mainly by reducing the return on holding idle cash with the RBI at the reverse repo rate so that banks and NBFCs find it better to lend, activating the real sector. To some extent, there may be a reduction in MCLR. However, MCLR responds more directly to changes in repo rate. With the prospects of a sharp fall in the CPI inflation rate, there is a likelihood of a further reduction in the repo rate by a margin of 25 basis points, in line with the reduction in the reverse repo rate."
Fixed deposit interest rates may fall further
As per the RBI governor's statement, "together with the measures announced on March 27, the RBI's liquidity injection was about 3.2 per cent of GDP since the February 2020 MPC meeting." The excess liquidity in the economy is expected to exert downward pressure on the interest rates.
Kamra says, "The liquidity measures by the RBI will put downward pressure on the interest rate. It is likely that banks will further reduce the interest rates on savings account and fixed deposit interest rates."
Sharma says, "On the personal investment side, there could be a possibility of interest rate cut on fixed deposits by 25 to 50 bps if the high liquidity persists in banking system."
Srivastava says, "Deposit rates respond more to repo rate changes. There may not be much effect on the current deposit rates as banks may wait for a repo rate reduction, which is likely in the next MPC meeting."
Veena Sivaramakrishnan, partner, Shardul Amarchand Mangaldas & Co. says, "RBI has made it clear that any measure that it adopts as a leeway / deferment for a borrower cannot lead to deterioration in the health of a bank. Therefore, while there may not be an immediate effect of cuts in interest rates, it is likely that if the uncertainty around revival of business continue, then there could be a drop for interest rates on retail deposits in the months to come."
What should FD investor do?
Sharma says, "All investors should know their risk appetite while looking for different investment avenues if there is falling interest rate scenario e.g. risk averse investors should look for safety of their money before looking at returns, given the volatility of the markets."
Source - ECONOMIC TIMES