An interesting observation by RBI governor when presenting the credit policy was that while banks were quite slow to lower their lending rates when the repo rate dropped, the commercial paper (CP) and certificate of deposit (CD) markets had reacted with alacrity. This also holds for government securities or G-sec yields as they are market-determined. There could be moderation, however, depending on liquidity conditions.
To get an insight into this reaction from markets, the changes in interest rates can be measured over time across segments. Broadly speaking, since June 2010, when the concept of base rate came in, there have been four interest rate regimes. The first was between June 2010 and October 2011, when the repo rate was increased by 325 bps (basis points — one bps is 0.01%).
This was followed by a softer era of declining rates between April 2012 and May 2013, when the repo rate was lowered by 125 bps.
Subsequently, the RBI started raising rates once more from September 2013 onwards till January 2014 by 75 bps before plateauing for the next 12 months or so. Since January 2015, rates were dropped three times, of which two were before this policy announcement.
The chart shows how various rates have moved under these regimes and the direct response of banks comes through changes in the deposit and base rates. Here it is assumed that the response comes one month after the repo rate changes as there are processes to follow before they are revised.
To maintain comparability, the same is done across other markets such as 10 years’ G-sec, 91 days T-bill, CP and CD.
The responsiveness of market-oriented instruments has been the quickest to changes in the regulatory rate. The third regime presents a distorted picture in terms of direction of movement mainly due to the 2013 being unusual due to the global currency crisis, which had the RBI intervening repeatedly. This had increased the rate till August when the yields peaked, thus distorting the calculation.
If this regime is excluded, then it does show that the CP market has been more favourable for corporates where the buyers are both banks and other institutions like mutual funds? The same holds true for the other market-driven instruments and hence, the efficacy of policy will be stronger in these segments.
Also, curiously, banks are faster to increase lending rates as compared to deposit rates and slower when lowering lending rates relative to deposit rates, which helps them to protect and increase their spreads as either way the differential is maintained.
The implications are clear. If banks are going to be less inclined to lower rates, companies would prefer to unbundle their requirements for short-term funds from the aggregate and access the CP market. As commercial paper has to be rated by credit rating agencies, the investor too would be better off in terms of quality of borrower, which combined with a lower interest rate that excludes the cost of intermediation, would be a win-win for all parties.
In FY15, for instance, there has been an upsurge in the issuances of CP with a total of Rs 11.5 lakh crore being issued as against Rs 7.3 lakh crore FY14 and Rs 7.65 lakh crore in FY13.
Outstanding CPs (as of March 2015) as a proportion of outstanding bank credit was 30% compared with 18-20% in the preceding four years. There appears to have been some migration in FY15 to this market.
The CP market provides access to entities other than banks to potential borrowers and as financial systems evolve, companies will prefer this route. The comfort level with banks has been a reason for companies to go in for bank credit.
But if banks remain intransigent when lowering interest rates, there could be an unbundling of requirements, where term loans would be a banker’s domain while short-term requirements would be met progressively through the market.
The former too could change once the corporate debt market gains momentum. In FY15, the average differential between the average CP rate and base rate was just 25 bps, and has been coming down. In FY12 and FY13, this differential was around 88 bps and 40 bps in FY14.
This could be a warning signal to banks as the better-rated companies could just start this migratory process to begin with.
To get an insight into this reaction from markets, the changes in interest rates can be measured over time across segments. Broadly speaking, since June 2010, when the concept of base rate came in, there have been four interest rate regimes. The first was between June 2010 and October 2011, when the repo rate was increased by 325 bps (basis points — one bps is 0.01%).
This was followed by a softer era of declining rates between April 2012 and May 2013, when the repo rate was lowered by 125 bps.
Subsequently, the RBI started raising rates once more from September 2013 onwards till January 2014 by 75 bps before plateauing for the next 12 months or so. Since January 2015, rates were dropped three times, of which two were before this policy announcement.
The chart shows how various rates have moved under these regimes and the direct response of banks comes through changes in the deposit and base rates. Here it is assumed that the response comes one month after the repo rate changes as there are processes to follow before they are revised.
To maintain comparability, the same is done across other markets such as 10 years’ G-sec, 91 days T-bill, CP and CD.
The responsiveness of market-oriented instruments has been the quickest to changes in the regulatory rate. The third regime presents a distorted picture in terms of direction of movement mainly due to the 2013 being unusual due to the global currency crisis, which had the RBI intervening repeatedly. This had increased the rate till August when the yields peaked, thus distorting the calculation.
If this regime is excluded, then it does show that the CP market has been more favourable for corporates where the buyers are both banks and other institutions like mutual funds? The same holds true for the other market-driven instruments and hence, the efficacy of policy will be stronger in these segments.
Also, curiously, banks are faster to increase lending rates as compared to deposit rates and slower when lowering lending rates relative to deposit rates, which helps them to protect and increase their spreads as either way the differential is maintained.
The implications are clear. If banks are going to be less inclined to lower rates, companies would prefer to unbundle their requirements for short-term funds from the aggregate and access the CP market. As commercial paper has to be rated by credit rating agencies, the investor too would be better off in terms of quality of borrower, which combined with a lower interest rate that excludes the cost of intermediation, would be a win-win for all parties.
In FY15, for instance, there has been an upsurge in the issuances of CP with a total of Rs 11.5 lakh crore being issued as against Rs 7.3 lakh crore FY14 and Rs 7.65 lakh crore in FY13.
Outstanding CPs (as of March 2015) as a proportion of outstanding bank credit was 30% compared with 18-20% in the preceding four years. There appears to have been some migration in FY15 to this market.
The CP market provides access to entities other than banks to potential borrowers and as financial systems evolve, companies will prefer this route. The comfort level with banks has been a reason for companies to go in for bank credit.
But if banks remain intransigent when lowering interest rates, there could be an unbundling of requirements, where term loans would be a banker’s domain while short-term requirements would be met progressively through the market.
The former too could change once the corporate debt market gains momentum. In FY15, the average differential between the average CP rate and base rate was just 25 bps, and has been coming down. In FY12 and FY13, this differential was around 88 bps and 40 bps in FY14.
This could be a warning signal to banks as the better-rated companies could just start this migratory process to begin with.
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