Mayur was hooked on to TV to know the outcome of RBI Monetary Policy committee meeting. As was the expectation floating around, the RBI had announced a 25 basis points rate cut (0.25%). He was rejoicing like millions others who were hoping for a downward adjustment in the repo rate without knowing what the rate stands for. Equation was plain and simple. Repo rate lowered = mortgage rate lowered. He dialed the bank’s number,
“Hello, I am Mayur Shah and my home loan account number is 612819376.Today it was announced the repo rate was lowered by .25%. When shall my mortgage rate be lowered?”
“Hello Sir, Nilesh Gokhale speaking from home loan division. How are you. The rate revision for your mortgage will be done at the beginning of subsequent quarter. It’s mid of Feb now, the revised rate will be applicable from 1st April “
“Gokhale, why not immediately. There is still time for April fool”, he was being sarcastic, out of desperation and familiarity with Account Manager.
“No Mr. Mayur. In fact, I was waiting for your call, never doubted your intelligence, never will. The change shall reflect by default; you could check it online”
Mayur waited for 1st April. The home loan rate had been readjusted but only by 0.15%. Mayur was furious. He called Gokhale again
“Nilesh, why did I not get the full reduction of 0.25% “
“Sir, just give me a chance to explain. The mortgage loan you availed is based on MCLR (Marginal Cost of funds based Lending Rate). The banks have to consider the cost of funds it uses to give loans to borrowers. Each bank has its own MCLR based on the cost of funds where repo rate change does affect the cost but only to an extent as it cannot lower the deposit rates for its customers overnight which are source of long term funds. Sir, let me ask you a question. Do you have an FD in any bank?”
“Yes”
“Has your bank ever changed your deposit rate in between the tenure because the RBI reduced repo rate”
Mayur pondered hard and replied with an elongated no.
“You see then; banks are tied with deposit rates which they cannot change on the liabilities side but are expected to pass the full rate change immediately on the asset side. Perfectly alright” the sarcasm was returned with interest by the banker.
“But RBI lowers the rate so that banks can increase their banking book by disbursing more assets. More volumes of assets shall surely compensate for the lower NIM”
Mayur was referring to the hit banks take on Net Interest Margin which is the difference between the interest received by bank on its assets(loans) and the interest paid on deposits and other borrowings(liabilities) by lowering rates on loans but not on deposits after the repo rate cut.
“Sir, CRR rate was reduced in December last year from 4.5% to 4%. Its’ the money banks have to park with RBI. It’s one of the measures to ensure that credit offtake is less than the deposits. So, if the bank receives Rs.100 as deposits, Rs 4 now instead of 4.5 earlier, is kept with RBI to ensure that bank has liquidity available during contingency, sort of safety mechanism. The CRR reduction infused money in the system, and now the repo rate cut too. Yet there are two problems here. First, the manufacturing sector, which is the primary component for driving growth of assets/loans has grown by 3.5% in Q3 FY24-25 over Q2, however it is 14% lower than Q3 of FY23-24. So, the credit offtake has not increased proportionately to improve the NIM through bigger asset book. Second, the banks are inherently facing liquidity crunch inspite of CRR cut, so they are reluctant to cut the deposit rates on liabilities side”
“Wait, banks are facing liquidity crunch. You mean banks don’t have money. How’s that even possible?”
“Multiple reasons have caused this effect Sir. Advance tax payments by companies in Q3 drives the cash out of the banking system. The withdrawals are higher in this closing part of the year due to festive season. Additionally, RBI had to intervene to protect the Rupee depreciation by selling Dollars in the market. Basically, RBI sells dollars and receives Rupees which reduces the liquidity in the system further. As if all these were not enough, banks were hit with slowest growth in deposits in the October –December quarter.”
“How do banks manage the deficit then?”, Mayur had by now completely gone off the trajectory and seemed intrigued by the dynamics of banking complexities.
“Banks slide over these patches of liquidity crunch by short term borrowing from RBI or through other banks in the call money market but if the crunch continues, it all adds to the cost of funds and burdens the financial ecosystem”.
“Thanks Gokhale, never knew about all this to assume that I should get exact rate cut as the repo change”.
“Sir, you can switch from MCLR to RLLR which is repo linked lending rate by paying a nominal switching fee. So, you get the exact cut in your mortgage loan as much as the reduction in the repo rate”.
“But I also get the exact hike in my loan when the repo rate increases. Gokhale, I am wiser than I sound”.
“I was coming exactly to that point. It’s a double edged sword, during rate hike MCLR will not rise exactly as the change in repo which RLLR surely will”.
“Thanks Gokhale for educating me on this topic. Half knowledge is indeed a dangerous thing. I shall be in a better position to take a decision on my loan in future thanks to you”.
“Don’t mention Sir. Now that you are well informed, let me brief you of an upcoming project in Manish Nagar area ….
“Hello,. Hello .. can’t hear you Nilesh. Hello.. I’ll call you back”.