Banks using repo rate cuts to hedge loan losses, says RBI

The need to hedge losses from non-performing loans is holding back banks from transmitting gains from the reduction of policy lending rates by the Reserve Bank of India, according to RBI.

RBI said the low transmission of RBI rate cut reflects banks' preference to protect profitability in the wake of deteriorating asset quality and higher provisioning.

This in effect means the honest borrower bearing the brunt of non-repayment of loans by the non-creditworthy borrowers.

Against a 150 basis point reduction in the central bank' policy rate between January 2015 and April 2016, banks have managed to bring down their median base rate by a mere 60 bps. On the other hand, the decline in median deposit rates has been more prominent at 92 bps during the same period.

The RBI said that this reflects banks' preference to protect profitability in the wake of deteriorating asset quality and higher provisioning. ''The weighted average lending rate (WALR) on fresh rupee loans declined by 100 bps (up to June 2016), significantly more than the decline of 65 bps in WALR on outstanding rupee loans,'' the RBI said.

''While the cost of funding by banks has declined somewhat leading to a decline in shorter maturity MCLR, there has been an increase in the term premia in respect of term loans of one year and above, thereby attenuating the transmission to actual lending rates charged to customers,'' it added.

Banks might have been loading a higher credit risk premia on their new customers in order to attain their desired return on net worth in a rising NPA environment. The RBI said that banks may also have been charging a higher strategic risk premia on their riskier loans as part of their business strategy to reorient their lending operations towards less risky activities.

''The consequent rise in the spread is reflected in a near unchanged WALR in respect of both outstanding and fresh rupee loans during 2016-17 so far (up to June),'' said the RBI. Governor Raghuram Rajan also said that the willingness of banks to cut lending rates is muted. ''Not only does weak corporate investment reduce the volume of new profitable loans, their stressed assets have tightened capital positions, which may prevent them from lending freely,'' Rajan said.