Transfers of deposits better in interest rate easing cycle than in tightening

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Transfers of deposits better in interest rate easing cycle than in tightening

The transmission of deposits to banks seems to be better in an interest rate easing cycle than in a tighter monetary tightening period, according to data released by the Reserve Bank of India RBI in its latest monthly bulletin.

In the easing cycle between February 2019 and March 2022 the benchmark was cut by 250 basis points bps, resulting in a reduction of their median term deposit rates or card rates by 208 bps. The average domestic term deposit rates WADTR of the US was reduced by 188 bps during that period.

On the lending side, while the one-year median marginal cost of funds-based lending rate MCLR was cut by 155 bps, the weighted average lending rate WALR decreased by 232 bps and 150 bps on fresh rupee loans.

In the tightening period beginning in May 2022 and continuing, while the six-member rate setting body the monetary policy committee MPC hiked the benchmark by the same amount as in the easing cycle 250 bps, the transmission to lending and deposit rates has not been similar to what was seen in the easing cycle.

The median term deposit rates went up 82 bps, while the WADTR on outstanding deposits went up by 87 bps in this tightening period. The increase in deposit rates did not happen immediately as the system started raising rates because of the surplus mode in which liquidity was in the system. Banks started increasing deposit rates in order to raise the credit growth after the tightening of the credit growth.

The one-year has moved up by 135 bps, while the WALR on fresh rupee loans and outstanding rupee loans has increased by 149 bps and 86 bps on the one-year. The EBLR's external benchmark linked lending rates have moved in tandem with the increase in repo rates. Banks usually hike when their cost of funds rises, so transmission in is lower than EBLRs, where it happens by default.

In an easing cycle, banks tend to reduce deposits faster than on loans to protect their margins, according to experts. In the tightening period, banks are slow to increase their deposits, but lending rates move up sooner.

Prakash Agarwal, head financial institutions, India Ratings Research, said that banks would sluggish in reducing lending rates in easing cycles, and in a tightening cycle deposit rates would move up with a lag because this would be margin accretive for the lenders. There was a goal of the introduction of the EBLR regime to improve the lagged as well as insufficient transmission of policy rates. In the present conditions, most of the retail portfolio of banks is linked to EBLR as a result of the loan rates in this portfolio moves in tandem with policy rates. However, transmission of deposits also depends on the credit market conditions as well as the liquidity conditions.