Time now for a surgical strike
“Invert, always invert,” said legendary investor Charlie Munger. As the ‘Dil maange more’ chorus for a rate cut reaches a crescendo, what is top of mind for the policymakers is how to ensure transmission of rate impulses permeates through the system in a seamless and timely manner. For that, we need to invert! We should look at policy action not from the MPC framework and mandate point of view, but from how banks respond to policy rate cuts and see what impedes transmission and how to address them.
To understand the transmission dynamics, we need to acknowledge that transmission has been effective for a set of borrowers while some others have yet to gain in a similar manner. Large corporates, retail customers seeking collateralized loans and existing SME borrowers have benefited because of their access to capital markets and loans linked to external benchmark-linked rates (EBLR). On the contrary, transmission has been lagging in MCLR-linked loans, as also fresh loans to customers who primarily rely on banks for their funding (neo-corporates). Let’s peel the onions more.
The Reserve Bank of India (RBI) front-loaded 100bps rate cuts during February-June. In April, it also changed the stance to accommodative, and made liquidity conditions very comfortable. With the last 50 bps rate cut, it reverted to neutral stance by June, and absorbed the excess liquidity from the system to ensure that the call rate stays aligned to the repo rate. This seeded some confusion in the market, with participants becoming nervous about the continuity of the rate cut cycle. Hence, clear communication is very crucial to ensure market responses in line with policy objectives.
The reaction from banks to rate cuts has also been logical. To ensure that their profit metrics and returns to shareholders are not diluted, they tried to dampen the immediate impact of the rate cuts on their profits. What was not in their control was the EBLR portfolio that repriced instantaneously, eroding margins in a material manner. To recoup some of the margin dilution, banks resorted to cuts in savings deposit rates (unforeseen in the last 15 years) as a first defensive measure. The second reaction of banks was to try and increase credit spreads wherever they had pricing power. Sanctions of new facilities to ‘neo-corporates’ have likely seen credit spreads expand (anecdotal evidence amid lack of proper data) as the second defensive measure. The benchmark rate at which these facilities are sanctioned would be lower than before, but the spread over the benchmark rate may have increased. Interestingly, MSME, being the highest net interest margin-accretive sector, has seen a spike in bank credit growth to approximately 20%.
When we look at policy actions going forward, it is now important to be clear on ‘For whom is the transmission not efficient and how do we make it happen?’.
It is clear that the immediate objective should be to align transmission to policy actions for the neo-corporates. We can broadly define this segment as entities that almost entirely rely on banks for their financing and have aggregate bank credit limits of less than ₹500 crore.
What RBI can do
If we define this as a goal, what actions would reduce borrowing costs for this set of borrowers? Just a blanket rate cut is not going to help them, as that would disproportionately help the highly rated large corporates and possibly further slow the transmission process for them. What we need to do is to look at surgical measures to help banks transmit rate impulses in a timely manner. What can they be?
Targeted Longer-Term Refinancing Operations (TLTROs): RBI can provide refinance at 364-day T-Bill rates to banks against their SLR holdings for any incremental lending to corporates in this segment. This would improve transmission as cost of funds for banks align to market rates for such lending by banks.
Commercial paper: Such companies can opt to borrow up to 25% of their fund based working capital limits as CPs from their consortium banks. The banks can subscribe to their CPs or backstop the market issuance with their working capital lines.
NBFC lending/co-lending boost at lower rates: Lending by NBFCs to such entities at rates below 364-day T Bill plus 200 basis points can be refinanced by banks/Sidbi. The same can be made eligible by RBI for borrowing under the TLTRO window for banks.
Capital relief: RBI can reduce risk weights by half of their current prescribed levels on any lending to entities that have credit guarantee support from Government of India/nominated agencies.
The time to act is now. As William Butler Yeats asserts, “Do not wait to strike till the iron is hot; but make it hot by striking.”
Srinivasan Varadarajan is chairman and Kanika Pasricha is chief economic adviser at Union Bank of India. The views expressed are personal.
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