Banks and non-banking financial companies (NBFCs) are raising deposit and lending rates. On April 25, Bajaj Finance, a major player in the consumer finance business, increased interest rates on deposits by 60 basis points. A basis point is one hundredth of a percentage.
On April 18, the country’s largest lender State Bank of India increased its marginal cost based lending rate (MCLR) by 10 basis points. MCLR is a benchmark rate for financial institutions and this increase will increase repayment on corporate loans, home loans and car loans. Other lenders like Axis Bank and Bank of Baroda have also raised their MCLR recently.
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Lenders like HDFC Bank and ICICI Bank have also raised interest rates on deposits.
The important question is why is this happening? Take a look at the accompanying chart.
The chart shows the incremental credit to incremental deposit ratio of commercial banks operating in India since January 2020. This ratio is nothing but incremental debt divided by incremental deposits. Incremental credit is the increase in the outstanding credit of banks at any point in a year. Similarly, incremental deposits are the increase in the outstanding deposits of banks at any point in time in a year.
So, as of April 8, the latest data available, the incremental loans of banks in a year were 11 trillion. Incremental deposits in the same period were 15.3 trillion, which means an incremental debt deposit ratio of about 72%. This calculation has been done from January 2020.
The chart tells us that the incremental credit-deposit ratio has been rising for some time, after falling to an all-time low of 33% in September 2020, which means banks are lending more and, therefore, have access to finance those loans. Requires more deposit. This means that increased lending has increased competition for deposits, leading to higher interest rates on loans and deposits.
In addition, the liquidity in the financial system has also gone down. It is worth remembering that after the Covid pandemic, the Reserve Bank of India (RBI) printed and pumped money into the financial system. This was done to reduce interest rates and help the government, corporates and individuals to borrow at lower interest rates. It was expected that lower interest rates would encourage borrowing and help revive economic growth.
The excess liquidity in the financial system was more than 8 trillion at the beginning of March. However, it has since fallen 4.8 trillion as of April 29. This fall in liquidity has pushed up interest rates and yields on government bonds in general. The return on a bond is the annual return that investors can expect to earn when they buy the bond and hold it until maturity.
As of March 2, the yield on 10-year Treasury bonds issued by the government stood at 6.81 per cent. It has since risen to 7.14%, an increase of 33 basis points. The government sells Treasury bonds to meet its fiscal deficit, or the gap between what it earns and what it spends.
Lending to the government is considered the safest. So if the return on that lending increases, the return on other forms of lending needs to increase as well. This is another factor that is driving up lending rates.
In the times to come, it is expected that the RBI will raise interest rates to control inflation, which should push both deposit and lending rates even further. Of course, despite the increase, inflation may remain higher than deposit interest rates.