As promised, I’m doing a quick
follow-up post on the complications in the transmission of Repo rate cuts to
bank lending rates in India. The complication that I’m addressing here is the deposit
composition of Scheduled Commercial Banks (SCBs) and how it affects
the transmission of Repo rate cuts.
Before discussing composition, here are the
3 main types of deposits offered by SCBs:
Savings
Account Deposits:
Most of us (retail/ individual customers) have Savings
accounts with banks where we receive our salaries and from where we make our
daily living expenses. There are restrictions on the number as well as the
amount of withdrawals from these accounts. Also minimum balances are required
to be maintained in these accounts. Saving account deposits earn interest at a
fixed rate decided by the bank. Currently most leading banks offer 4% per annum
(interest is calculated on the daily balance).
Current
Account Deposits:
Current Account deposits are used by
businessmen or companies/firms etc. to conduct all the day-to-day transactions
required to run their businesses. There are no restrictions on the number or
amount of transactions in these accounts. These accounts do not earn any
interest. Banks do levy certain service charges on these accounts for all the
facilities that they provide.
Term
Deposits or Fixed Deposits:
In a Term deposit, money is deposited for a
certain tenure (7 days – 10 years or more) for which the depositor earns a
fixed rate of interest. The fixed rate on the deposit is decided by the bank, and
is usually directly proportional to the maturity of the deposit. The depositor cannot withdraw
money from the deposit before maturity without paying a penalty.
Now
that we know the main types of deposits offered, provided below is the deposit
composition for SCBs in India (in Mar 2014):
Source:
Basic Statistical Returns of Scheduled Commercial Banks in India - Volume 43,
March 2014.
Note: The % of current, savings and term
deposits in total deposits is shown in parenthesis.
The
data in the table above shows that in March 2014, of the total SCB deposits in India (~Rs 80 lakh Crore):
- Current A/C deposits stood at 9% (of total)
- Savings A/C deposits were 26.5%
- Term Deposits were 64.6%
Current Account and Saving Account deposits
are also called CASA deposits. (No points for guessing that CASA stands for “Current Account Savings Account”). CASA ratio for a bank = (CASA deposits/
Total deposits). As shown in the table above, in Mar 2014, the CASA ratio for SCBs as a whole was = 9% + 26.5% =
35.5%.
A higher CASA ratio is a favourable
metric because it means lower cost of funds for a bank since no interest is
paid out on current A/C deposits and the interest on Savings A/C deposits is
usually just 4% (much lower that what is paid out on term deposits). The higher the CASA ratio for a bank, the larger the proportions of low cost funds in its
deposit base, which means its average cost of funds is lower. This helps the
bank achieve a higher Net Interest Margin (NIM) i.e. achieve higher
profitability. NIM = interest income earned by bank – interest paid out by
bank.
What
happens when the RBI lowers the Repo rate? (Deposit side perspective)
When the RBI lowers the Repo rate, the cost
of CASA funds remains the same because no interest rate is paid on current
account deposits and the interest rate on savings accounts (4% currently for
most) remains the same (banks don’t change this rate easily).
The change in the cost of funds happens in the term deposit segment. However, this change too is very sluggish. Why?
Because term deposits are usually contracted at a fixed rate which the bank is
liable to pay till the deposit matures. Even when the bank drops the interest
rate it pays on new term deposits of similar maturity, it has to continue to
pay the higher rates contracted on its existing term deposits till their
maturity date.
Based
on RBI data, the maturity composition of SCB term deposits in Mar 2014 was as
follows:
Upto
6 months : 12.6%
6
months – 1 year : 14.3%
1
-3 years : 46.2%
3
years & above : 26.9%
This data shows that 73% of term deposits of Indian SCBs have a maturity of a year or longer. So even
if SCBs cut interest rates on new term deposits, 73% of their existing term deposit
base won’t see any movement in interest rates (costs of funds for the bank) before
a year. 73% of SCB term deposits = 73% * 64.6% = 47.2% of total SCB deposits.
Lets add the CASA ratio to this.
35.5%
(CASA ratio) + 47.2% = 82.7%.
Bottom-line:
Even when SCBs cut interest rates on new term deposits following a Repo rate
cut, 47% of their total existing deposits don’t see any movement in interest
rates (cost of funds) before a year, while 35.5% of their total deposits (CASA
ratio) don’t see any movement in interest rates at all (time factor irrelevant).
Overall, ~83% of total bank deposits see no movement in rates (cost of funds)
for a year following a Repo rate cut.
I apologize for being repetitive - am just
trying to underscore the fact that banks’ cost of funds doesn’t really respond
much to a cut in Repo rate in the short term. This is why transmission of the
cut to bank lending rates is hard. With
cost of funds not really falling in the short term, cutting lending rates squeezes margins.
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