Less than a week after the Union Budget, RBI governor Raghuram Rajan reduced the repo rate - the rate at which RBI lends to banks - by 25 basis points, to 7.5%, citing improved government finances. However, the burden of home and auto loans on borrowers is expected to ease only in April, the beginning of the new financial year. This is RBI's second rate cut in the last two months but only three of 45 banks - Union Bank, United Bank, and Karur Vysya - have so far lowered the benchmark rates.
Banks are yet to pass on the benefits of the earlier midterm cut in rates on January 15. “Since there is a lag effect for the monetary transmission to take place, effect of previous 25 basis points cut together with the present rate cut would encourage banks to review their base rates,“ T M Bhasin, chairman of Indian Bank, said.
Although banks have seen a marginal dip in cost of funds, they are reluctant to lower rates now due to earning pressure on account of rising bad loans. Also, the financial year end is the time banks try to beef up their balance sheet by aggressively mobilizing deposits and often offer better deals.
An immediate rate cut would reduce interest income for banks. Although some economists did forecast a rate cut given the improvement in the quality of fiscal deficit in the Budget, the timing of the rate cut took markets by surprise. Apart from announcing the cut midweek, this was also the first time that RBI announced its decision before markets opened for TRADING.