When the interest rates cool off, they resist passing them on to the borrowers. On the other hand, during such phases, they are quick to slash deposit rates.

Similarly, when the borrowing rates go up, banks start a race with one another to hike rates.

You’re witnessing similar behaviour today. The RBI’s Monetary Policy Committee (MPC) is scheduled to meet on June 06, 2018 for the second bi-monthly review of FY 2018-19. Before it clears its stance on the inflation, interest rates, and the growth estimates, the banks have already started raising borrowing rates.

Deposit rates are going up too, but, many experts believe the future rise in the borrowing rates would be steeper than that in the deposit rates.

For now SBI, HDFC Bank, Punjab National Bank (PNB), ICICI Bank, Kotak Mahindra Bank have increased Marginal Cost Of Funds Based Lending Rates (MCLR) by 10 to 20 basis points across tenures. One basis point is 1/100th of a per cent. With this the cost of loans per lakh of rupees will go up atleast by Rs 100.

Are you puzzled why banks have been so proactive this time?

There is no one answer to this. Let’s discuss it in detail.

First and foremost, please note, despite the growing dominance of private sector banks and Non-Banking Finance Companies (NBFCs), Public Sector Banks (PSBs) still hold the largest share of India’s credit market and their financial condition isn’t good for quite some time now.

Recently, PersonalFN wrote an article titled Read This If You Hold Deposits With Public Sector Banks, highlighting the glaring losses they incurred in the Q4, FY 2017-18 and the deteriorating asset quality denoted by the rising Non-Performing Assets (NPAs).

Have you heard about NIM—Net Interest Margin?

Higher the NIM, better the profitability of the bank and vice-a-versa.

Investopedia defines NIM as a ratio that measures how successful a firm is at investing its funds in comparison to its expenses on the same investments. A negative value denotes that the firm has not made an optimal investment decision because interest expenses exceed the amount of returns generated by investments.

In the Indian context, NIMs of PSBs are under pressure because of asset quality black holes.

At this juncture, the PSBs have two options to revive themselves—instill credit discipline and reap benefits in the future; or, use the combination of greater credit discipline and higher profitability.

If you don’t like to read complex financial phrases, here’s the simplified version for you.

PSBs have two options at present. They can become extremely sensitive to the risk of loss when granting a loan. In addition to this, they could raise net interest earnings, which is the difference between interests they pay and charge.

If they just become ultra-sensitive to the quality of loans sanctioned, they might gain in future. But, they will have to settle for lower growth—thereby losing market share. Alternatively, they can be ultra-cautions with pricing, the risk involved in lending to perfection.

If we assume, the worst of India’s NPA story that panned out between 2011 and 2018 is already behind us, then provisioning requirements would go down quite significantly in future.

It means, banks will have to set aside, lesser of their income to offset potential losses. During such a phase, if they can improve their NIM, they would recover faster than anticipated.

The SBI——-India’s largest state-owned lender——-is taking the position of the trend setter as far as rising interest rates is concerned. It recently raised interest rates on bulk deposits and it has also started the competition among lenders to hike borrowing rates.

SBI’s chairman Rajnish Kumar recently made an important comment in the recent past, “Last year was a year of despair. This year is a year of hope, and next year will be a year of happiness.”

In other words, he meant that the SBI has already left the worst behind it in FY 2017-18. It believes it can make progress towards reviving its lost glory in FY 2018-19, and FY 2019-20 would be the year of a boom.

In the banking industry, comments of SBI’s top bosses are never taken lightly, irrespective of the magnitude of difficulties the Bank might be facing.   

Macroeconomic factors are also working in their favour.

1. The slosh of liquidity the system experienced post demonetisation has receded gradually. In fact, we are facing a mild liquidity crunch, which is visible by the rising interest rates in the overnight borrowing market. In plain English, the money is getting expensive.

2. The difference in India’s 10-Year benchmark bond yield and the repo rate has risen alarmingly high to 189 basis points. Moreover, the real rate of return measured by the difference between retail inflation and benchmark bond yields is over 300 basis points now.  Both these factors indicate that we might have already seen the end of the easing cycle. And, RBI is likely to increase policy rates sooner rather than later. Perhaps, the market has already discounted the rate hike of 25 basis points.

3. The market is likely to see the oversupply of debt issuances, which might put pressure on the yields. Falling currency, likely chances of rising inflation and monetary policy normalisation in the U.S. might accentuate the further hardening of bond yields in India.

4. Credit demand from corporations has also seen some improvement lately.

To sum up

Banks are proactively raising lending rates to save their profit margins, discount their bad business decisions of the past, and also to adjust for the potential changes in the monetary policy stance of RBI in the foreseeable future.

For now, the impact of rising interest rates on your home loans, vehicle loans, and the personal loans might be limited. But, the recent rise in MCLR rates certainly indicates that the cheap loans are in the past and the rising cost of debt servicing will soon be reality.

Special note for readers

You should never ignore your personal finances.

While cheaper bank loans may look enticing during the monetary easing cycle, they might turn out to be nightmares once the cycle reverses. Therefore, it’s important for you to inculcate discipline in your credit behavior. Having a financial plan in place helps you understand how much debt you can handle.

You can know more about financial planning by sending us your queries either at info@personalfn.com or call us - 022-61361200. We will be happy to hear from you.

You can also Schedule a Call with our investment consultant here and we will get in touch with you. We would be delighted to plan your finances prudently to help you achieve your life goals.

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