Even as bond yields rose sharply following Reserve Bank of India's decision to hold rates, bankers expect interest rates to ease as banks will be flush with liquidity for some time. Helping to bring down the cost of funds for banks will be the withdrawal of the 100% incremental cash reserve ratio (CRR) requirement imposed on November 26.
This week, several banks, including HDFC Bank, Bank of Baroda, Bank of India and Dena Bank, reduced their benchmark lending rates without waiting for the RBI action. HDFC Bank had cut its one-year marginal cost of lending rate to 8.9% on December 6 to bring it on a par with SBI and ICICI Bank.
On December 7, the yield on the 10-year gilt shot up 20 basis points after the RBI decided to hold rates (100 bps = 1 percentage point). "Bond market, obviously, reacted negatively post policy with the benchmark 10-year paper rising 15-20 bps. However, inadequate deployment avenues would lead to range-bound movement in yields," said Melwyn Rego, MD & CEO, Bank of India.
Besides the improvement in liquidity, interest rates are expected to remain soft as loan demand has virtually dried up due to demonetisation and sharp drop in capacity utilisation. Retail lending, the biggest driver of loan growth in FY17, has seen a sharp slowdown because of demonetisation.
According to ICICI Bank MD & CEO Chanda Kochhar, deposit and lending rates are expected to continue their downward trend due to the improvement in liquidity.
Yes Bank MD & CEO Rana Kapoor said that the rollback of incremental CRR hike augurs well for the banking sector as a whole. "Post the outcome of the US Fed meeting, and stabilization of the demonetization initiative, in my opinion there will be room to deliver a 50-75 bps cut in the repo rate in the next post-budget meeting in Feb 2017, and surely by April 2017," he said.
R Sivakumar, head of fixed income at Axis Mutual Fund, said, "The banking system is likely to be flush with liquidity in the near-to-medium term in view of the surge in deposits.
Credit growth remains muted at the same time. Demonetisation and the emphasis on cashless/digital transactions would have a structural impact on the banking system. In this context, we expect short-to-medium term rates to remain contained. He said that yields on short-to-medium term bonds are likely to fall."