Despite there being a huge number of both public and private sector banks in India the entire banking industry works as a big oligopoly. The interest rate transmission mechanism is very poor and transparency even more so despite several efforts by the RBI to improve the same. This is extremely high in the case of Retail Floating Rates given by banks where the transmission is 150% on the way up and 50% on the way down. For example statistics reveal that post 2008 crisis when RBI reduced rates by 525 basis points besides cutting CRR several times the average lending rate reduction by Indian banks was just 128 basis points.

I will explain via a personal example. I have a housing loan from HSBC. This loan started off at an interest rate of 7.25% in the year 2005. At that time the repo rate was 6.25%. Subsequently as the repo rate moved up to 9% the interest I was paying moved upto as high as 13%. I did not protest against this as this is a feature of floating rate loans. However when the repo rate was subsequently cut by the RBI to 5% in the year 2009 the reduction in rates was barely 1%. When I wrote to the bank chairperson the rate was reduced to 9.25% from 11.5%. They were as it is offering this rate to new customers but not to the old ones. A lot of people will not understand how this happens. It is by increasing or decreasing the discount they had on the Retail Lending Rate which was different for different customers. For example when I took the loan the RLR would have been 10.5%, so I was at a 3.25% discount to that. In the tightening cycle of RBI they increased the RLR to 16.5% so my loan got repriced to 13.25%. However when the RBI cut rates they did not reduce the RLR as much but offered higher discounts to new customers. and ripped off the older ones.

Subsequently RBI increased rates again and in this cycle my housing loan rate moved up disproportionately again and then the entire cycle of writing to the Bank Chairperson had to be repeated. Even after that My loan is priced at 11.5% today whereas ideally it should be less than 11%.

Public sector banks, due to their high Non Performing loans are not able to participate in monetary easing as they have to make continuous provisions for bad loans.The relatively professionally run Private Sector Banks are able to use this to maintain high Net Interest Margins and are not pushed to reduce rates by PSU banks which is something that should happen in ideal circumstances.

Monetary transmission is something that RBI needs to work on strongly. Rated corporate’s are easily able to take advantage of the lower rates by issuing bonds or Commercial Papers for working capital financing. Banks do not ostensibly reduce rates even for them but subscribe to these CPs and hence circumvent the entire Base Rate process of the RBI. It is the retail borrower who has to suffer. Floating rates need to be implemented in letter and spirit. However we still have a long way to go before this happens.

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