With repo rate falling, govt must lower small saving interest rate mountain for banks

The country's largest bank, State Bank of India, followed quickly, passing on the entire repo rate cut to its borrowers by lowering lending rates linked to the repo rate and external benchmarks. At the same time, the bank reduced its retail term deposit rates by 20-50 bps. Considering monetary transmission was less than half before Friday's rate cut, much more remains to be done in lowering lending rates. And for that, banks will have to cut deposit rates far more than the 20-50 bps SBI did late last week. Before they do so, they will be hoping for some assistance from the government. To an extent, the government's small saving schemes compete with banks' deposits for the public's money.

The interest rates on the former, however, are far higher than those offered by banks. While a case can be made for banks not really requiring funds in the form of deposits at the moment--the system is in huge liquidity surplus even as demand for credit is weak--they need to prepare for the upcoming quarter on two fronts. Firstly, assuming the lockdown ends mid-April as scheduled, there will be a significant pent-up demand for credit from consumers and producers alike. Secondly, banks' profitability will take a massive hit in Apr-Jun quarter on account of the blanket three-month moratorium on term-loan installments, with even credit card payments being deferred. With interest income set to fall precipitously next quarter, banks must do all they can to curb interest expenditure to preserve some semblance of respectability to their net interest margins, particularly with the reverse repo rate being lowered by 90 bps to 4.00%.

RBI Governor Shaktikanta Das said Friday that the aim of making the Liquidity Adjustment Facility corridor asymmetric was to discourage banks from passively parking money at the reverse repo window. If banks can't deploy their funds outside of reverse repos, they will need to sharply cut deposit rates. The key to this, without hurting banks' ability to attract deposits from the public, will be reduced small savings rates.

Currently, the five-year National Savings Certificate offers a return of as much as 7.9%--a full 220 bps over SBI's revised retail five-year deposit rate. The link between small savings rates and yields on government securities of similar maturities exists only on paper. Between February 2019 and January 2020, the government cut small saving rates by just 10 bps while the yield on five-year gilts fell 73 bps. The government is expected to notify small savings rates for Apr-Jun by Tuesday. Needless to say, this decision will be more important than previous ones.

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