Bank rate transmissions quicker under external benchmark regime

Public sector banks almost fully transmitted their lending rates on new loans after the Reserve Bank raised its policy rates in May by 40 bps. Overall banks raised transmitted 35 percent bps on fresh loans. But weighted average lending rates on outstanding loans rose 7 bps, weighted average rates on outstanding deposits rose by only 4 bps during the month, latest RBI data indicates.

Data indicates that weighted average lending rates on fresh loans was up bps for 37 bps for public sector banks to 7.14 percent and only 26 bps for private banks to 8.79 percent in May. One basis point is 0.01 per cent. It may be recalled that the Reserve Bank raised its benchmark repo rate in between the monetary policy committee’s (MPC) scheduled reviews by 40 bps to 4.40 percent to rein in inflation that has been persistently above the central bank’s comfort level of 2-6 per cent.

The recently released Financial Stability report notes that the shift of banking sector towards the external benchmark linked lending rate (EBLR) based pricing of loans has improved the pace and extent of monetary policy transmission. ” Most banks have chosen the Reserve Bank’s repo rate as their external benchmarks. Under the EBLR regime, the shift in interest rate cycle will have a quicker impact on both deposit and lending rates of banks”.

Among the bank groups, private banks raised rates more sharply than their public sector counterparts. The weighted average lending rates (WALR) on outstanding loans was up by a modest 3 bps for public sector banks raised lending rates by, private banks raised them by 14 bps.

Analysis in the Financial Stability Report says that banks have extended the benefits to existing borrowers by reducing the WALR more than the repo rate cuts during the EBLR period. The pace of transmission is expected to improve going forward as the proportion of external benchmark linked loans increases further, the report said.

Subsequently in June too MPC voted for raising repo rates by a further 50 bps to 4.9 per cent in its June meeting as sustained high inflation could unhinge inflation expectations and trigger second round effects. It felt that further monetary policy measures are necessary to anchor the inflation expectations. Future data will show the impact of these measures.