Why The New BR Regime Will Not Fly

The Reserve Bank of India (RBI) is set to come out with its final guidelines on a new Base Rate (BR). It’s seen as a bonanza for borrowers, who it is expected, will be able to borrow cheaply. However, it’s not so simple.

The current clamour from industry and retail for a brand new BR has to be seen in context – that despite repeated rate cuts by Mint Road, India Inc, you and I still borrow at stiff rates; the argument put forward is banks have not passed on the rate cuts or worse are not willing to.

While Mint Road left the repo rate unchanged at 6.75 per cent at its last review, it had obliged with a 50 basis points (bps) cut to 6.75 per cent -- a four-and-half-year low – in September.

The September cut was a front-loaded one, and as Dr Raghuram Rajan then noted: “While the Reserve Bank’s stance will continue to be accommodative, the focus of monetary action for the near term will shift to working with the Government to ensure that impediments to banks passing on the bulk of the cumulative 125 bps points cut in the policy rate are removed”.

Mint Road’s stance is the new BR “based on the marginal cost of funds should be more sensitive to changes in policy rates. To improve the efficiency of monetary policy transmission, (we) will encourage banks to move in a time-bound manner to marginal cost of funds-based determination of their BR,” RBI had said. The idea behind a new BR based on marginal cost of funds is that it will be more sensitive to policy rate changes.

But what’s lost in the din is the fact that banks’ cost of deposits are already locked in. It will come down only over time (with a lag) and will not reflect immediately in lower BRs. It’s a different matter though that banks will pass on higher deposit costs  quickly to borrowers!

The BR as Chimera
As for banks, when the new BR regime kicks in, they will take a hit on profitability. Pawan Agrawal, Chief Analytical Officer-CRISIL Rating, has been of the view that a one-time impact of around Rs 20,000 crore in fiscal 2017 is on the cards. Or equal to 15 per cent of the total estimated profit of the banking system. “The actual impact will depend on whether the banks will be given a leeway to make this shift over a longer timeframe in the final guidelines”, he said.

Now what you might well see is banks who are quick to reprice deposits will move aggressively on the BR front too. This might lead to a “switch” by customers to the likes of HDFC Bank, ICICI Bank, Axis Bank, State Bank of India, and a handful of relatively better run state-run banks. The laggards will take a bigger hit on profitability, their valuations may dip further and ahead of Basel-111 which kicks in from fiscal 2019 may find it all the more tough to raise capital.

It was from 1st April 2010 that the BR concept kicked in. Until then, it was the benchmark prime-lending rate (BLPR). A large universe of borrowers had their loan priced below it. At that point in time, the RBI pointed that the share of sub-BPLR lending by banks (excluding export credit and small loans) increased to 70.4 per cent in September 2009 from 66.9 per cent in March 2009. Strangely enough, the whole idea underlying the BPLR was that it was to act as a BR — with top-most rated borrowers getting funds at the rate. But it had created confusion – what is the BPLR to signal if the world borrowers both below and above it. Folks who borrowed below the BPLR had little reason to complain if it (the BPLR) continued to hold firm despite repeated policy rates cuts; ones who borrowed above it thought the world was unfair to them!

How The BR Works

Cost of Deposits: To be calculated using the latest interest rate payable on CASA (current and saving accounts) deposits and term-deposits. The cost of borrowings is to be arrived at using the average rates at which funds were raised in last one month preceding the date of review Negative carry on reserves (CRR and SLR): This would be based on the marginal cost of funds calculated above, implying negative carry will increase or decrease with an increase or decrease in cost of funds (negative carry will decline when deposit rates are cut) Un-allocable Overhead Costs: It is to remain fixed for three years Average Return on Net Worth: This is the hurdle rate of ROE determined by the Board or management of the bank. RBI expects banks to keep this component fairly constant and any change be made only in case of a major shift in business strategy Source: Religare Institutional Research