In a first of its kind, the nation’s largest lender State Bank of India (SBI) announced linking of its savings deposits rates and short-term loans to the Reserve Bank of India’s (RBI) repo rate. The new rates, linked to the external benchmark rate, would be effective from May 1, the bank said in a statement.

The move would help speed up the monetary transmission process wherein lenders pass on RBI’s rate cuts as well as hikes to borrowers. The RBI has been unhappy with delays in transmission of rate cut benefits by the banks. SBI said it would exempt savings bank account holders with balances up to Rs 1 lakh and borrowers with cash credit accounts and overdraft limits up to Rs 1 lakh from linkage to the repo rate. This would insulate small deposit-holders and small borrowers from the movement of external benchmarks.

The move comes ahead of the April 1 deadline for banks to link the lending rate to the external benchmark which is aimed at increasing the effectiveness of monetary transmission. Currently, repo rate is 6.25 per cent.

“To address the concern of rigidities in the balance sheet structure and address the issue of quick transmission of changes in the RBI policy rates, effective from May 1, 2019, we have taken the lead in linking key pricing decision for savings bank deposits and short-term loans to the repo rate of the RBI,” SBI said.

Savings bank deposits above Rs 1 lakh constitutes around 33 per cent of SBI’s total deposit books, SBI managing director P.K. Gupta said. Currently, the bank is offering interest rate of 3.50 per cent for savings bank deposits up to Rs 1 crore and 4 per cent for deposits above Rs 1 crore, he added. “This is a major policy decision we have taken. A 25 basis points reduction in the repo rate can result in a 7-8 basis points cut in our MCLR now,” Gupta said.

What is MCLR?

Loans such as for car and home are linked to marginal cost of funds-based lending rate (MCLR). RBI introduced the MCLR system with effect from April 1, 2016 on account of the limitations of the base rate regime. It is an internal benchmark rate that depends on various factors such as fixed deposit rates, source of funds and savings rate. The price of loan comprises the MCLR and the spread or the bank’s profit margin. 

How different rate models evolved?

Despite the recent RBI rate cut, banks were struggling to reduce their lending and deposit rates as the deposit accretion continued to lag credit growth. Cutting deposits rate was not a feasible option amid slowing deposit growth. It can be recalled that banks were always slow to pass on the entire benefit of RBI rate cuts to borrowers, thus delaying the monetary transmission process. 

This disconnect had forced governor D.Subbarao to end the BPLR (Benchmark Prime Lending Rate) regime, which was very opaque and usher in the bank rate in 2010. But this too did not have the desired effect as the new pricing regime was opened only to new borrowers and the existing borrowers, who are the vast majority lost out.

Following this, his successor Raghuram Rajan made bankers change the model and ushered in the base rate regime, again without much success on the monetary transmission front. Then, Urjit Patel ended the base rate regime and launched the MCLR (Marginal Cost-Based Lending Rate) regime. 

However, banks were slow to move on the transmission front, forcing him to announce that from April 2019, all loan pricing will move onto an external benchmark. The central bank has given three options — policy repo rate, 91 days treasury bill yield, 182 days treasury bill yield or any other benchmark market interest rate produced by the Financial Benchmarks India Pvt. Ltd.