Empty cashier counters are pictured at a State Bank of India branch in Bengaluru. Photographer: Namas Bhojani/Bloomberg News

SBI’s New Interest Rate Strategy: Experts Weigh ln

State Bank of India has become the first domestic lender to link the interest rate offered on savings bank deposits over Rs 1 lakh to the Reserve Bank of India’s repo rate. Starting May 1, these deposits will earn interest at 2.75 percent below the repo rate, which currently stands at 6.25 percent.

Interest rates on cash credit and overdraft will also be linked to the repo rate. These will be priced at 2.25 percent above the repo rate. An additional spread based on a borrower’s credit quality will also be added to arrive at the final interest rate.

The decision, if followed by other large lenders, will mark an important shift in the pricing of deposits and loans in the Indian banking system.

So far banks have linked interest rates to their own cost of funds. However, since cost of savings and current account deposits were constant, the cost of funds did not adjust to policy rate changes in a timely manner, leading to concerns about delayed transmission of monetary policy in the economy.

SBI’s decision could help change that to some extent.

“Transmission can’t happen only on one side. This is where external benchmarking comes in,” said Rajnish Kumar, chairman of State Bank of India on the sidelines of an event in Mumbai. “By linking savings bank accounts to repo rate, the Marginal Cost Lending Rate will also get adjusted automatically with the change in repo rate,” Kumar said.

Under SBI’s new interest rate strategy, retail loans, including home loans, will continue to be linked to MCLR. Every 25 basis point change in the repo rate will impact MCLR linked loans by 7-8 basis points.

How Will Depositors React?

SBI depositors, with balances of more than Rs 1 lakh in their savings accounts, will see greater volatility in the interest rates they earn. Each time the RBI changes its repo rate, the interest earned on these savings accounts will move commensurately.

This volatility could prompt some customers to either move towards fixed deposits or look to park funds in smaller private banks which offer higher rates on savings accounts.

“In the current environment where the inflation trend is downward, if you were to introduce an external benchmark for longer term deposits, you will face some resistance from depositors. The best way to deal with this would be to wait for a cycle where interest rates are going up, introduce an external benchmark and get customers used to the structure,” said HR Khan, former deputy governor, RBI.

However a senior retired public sector banker, while speaking on condition of anonymity, said the risk of a shift in savings account deposits is low. The withdrawal of savings account deposits is not very fast, so you can afford to have a rate that fluctuates, depending on the way the market moves, this banker said. This person added that SBI’s decision not to link fixed deposits to an external benchmark is correct because of a lot of Indians depend on earnings from fixed deposits.

Madan Sabnavis, chief economist at CARE Ratings also does not see a risk of a shift in deposits for SBI or other banks that link rates to an external benchmark.

“Kotak Mahindra Bank and Yes Bank have been offering higher interest rates in comparison to other market players but that has not led to consumers preferring these banks over the others per se. However, it is possible that some customers may now prefer making a switch within the same bank to fixed deposits assuming that they are willing to park funds for longer and spending on the spread between the two,” Sabnavis said.

Will It Impact SBI’s Margins?

A December proposal by the Reserve Bank of India, which suggested that banks link floating rate retail loans to an external benchmark, had raised concerns about an adverse impact on bank lending margins.

By first linking a part of its deposit base to an external benchmark, SBI is not likely to face significant margin pressure at the current juncture. With every change in repo rate, 32 percent of the bank’s deposit base will be repriced, explained PK Gupta, managing director of SBI. Lending rates on MCLR linked loans will, in turn, adjust by 7-8 basis points.

“There is pressure to mobilise deposits given slowing deposit growth and if there is rate cut in the next policy announcement, then this move can reduce cost of funds for banks and they will be protected on their margins,” said Anil Gupta, head of financial sector ratings at ICRA. Gupta agreed that the decision to link savings deposits to an external benchmark will be less disruptive for the bank as compared to linking fixed deposits. “It is difficult to reprice the fixed deposits as it is sensitive to the interest rates while saving deposits may not be impacted immediately to the changes in the rate.”

According to Khan, banks must link their liabilities and assets, both, to an external benchmark to manage their margins better.

Will It Improve Transmission In The Economy?

One reason behind SBI’s decision is the pressure from the central bank on lenders to improve transmission of interest rate changes in the economy.

The RBI has made a number of changes to the lending rate formula used by banks to improve transmission. However, each change has only helped marginally.

Should SBI’s move be followed up by other banks, transmission could pick up.

“The external benchmarking system will allow transmission of changes in the benchmark monetary policy rate in a commensurate manner, conditional on whether all banks choose to move to a similar structure. The move also reflects the failure of the previous system to transfer policy rates,” said Sabnavis of CARE Ratings.

Shyam Srinivasan, chief executive officer of Federal Bank believes that other lenders will slowly move towards external benchmarking, thereby improving transmission.

"Our bank has launched a type of savings bank account, where the interest rate is linked to an external benchmark. We have our home loan product linked to an external benchmark as well. With the RBI deadline nearing, you will see more banks experimenting with external benchmarks. But banks will have to link deposits and loans, both to an external benchmark, to avoid any volatility in margins,” Srinivasan told BloombergQuint.

((Advait Rao Palepu contributed to this report))