Banks are unlikely to lower lending rates immediately though the Reserve Bank of India on Friday cut the repo and the reverse repo rates to all-time lows in an attempt to boost demand and spur economic activity.
In addition, the cash reserve ratio, or the proportion of deposits that banks set aside, will be lowered by 50 basis points - the lowest since February 2006 - from the fortnight starting January 17. This will inject Rs 20,000 crore (Rs 200 billion) into the system. The move will also help banks earn more as the RBI does not pay interest on the funds that are set aside to meet the CRR requirement.
The measures taken today included reduction in repo and reverse repo rates by 100 basis points each to 5.5 per cent and 4 per cent, respectively. The RBI had introduced the liquidity adjustment facility, through which it lends to banks at the repo rate and borrows at the reverse repo rate, in 2000. The cuts are applicable with immediate effect, according to the RBI.
"Banks should price risk appropriately and ensure that quality enterprises continue to get funds. The RBI appreciates that risk management is difficult even in normal circumstances; it is more difficult in an environment of uncertainty and downturn," said the RBI.
This is the fourth round of rate cuts since the global credit crisis intensified in September following the collapse of US financial institutions. Since October, the CRR and the repo rate have been lowered by 350 basis points each. During the last four weeks, the reverse repo rate has come down by 200 basis points.
Taking cue from the RBI, public sector banks have cut benchmark prime lending rates by up to 200 basis points, while the reduction by private banks has been in the range of 50 basis points. The decline in deposit rates has been steeper.
While a few lenders (such as IndusInd Bank) which have not pared their rates so far are expected to announce rate cuts in the coming days, others are expected to wait for some time as the latest reduction in lending and deposit rates by banks was applicable from this week. Banks which have already reduced rates said they would first cut their deposit rates in the coming weeks.
"The banking system is headed towards a lower rate regime as most banks are likely to cut lending rates. We will cut benchmark lending rates in two tranches. We may cut our rates by at least 50 basis points within eight-ten days, while a further cut will be made with a 15-day lag. But the deposit rates will be reduced by a similar scale before we cut our lending rates," said IndusInd Bank MD & CEO Romesh Sobti.
IDBI Bank, which has so far not reduced its lending rates after the last round of rate cuts by the RBI, did not indicate if it was willing to do so now. "The economic stimulus package will partly help generate demand. The problem is not of credit availability but demand. Credit is available for viable proposals," said chairman and managing director Yogesh Agarwal.
"Through these measures, the RBI wants to ensure ample liquidity in the banking system. The CRR cut will help soften the cost of deposits, which will encourage banks to lend to both retail and corporate borrowers.
"Our asset-liability committee (Alco) will take a decision on further rate cuts only after assessing the impact on our cost of funds due to these measures. There will definitely be a reduction in the cost of funds but it is too early to quantify any cut that we may make in our lending and deposit rates," added HDFC Bank's head, trading, Tarini Vaidya.