Mumbai: Banks would find it difficult to pass on the benefits of a rate cut by RBI to borrowers as they continue to feel refinancing pressure, says India Ratings.
The rating agency said only a reduction in the cash reserve ratio can help banks cut lending rates and thus aid effective monetary policy transmission.
"Monetary easing is more likely to be driven by a cut in the cash reserve ratio (CRR) than a reduction in the repo rate, which will enable banks to offset the impact of a base rate reduction on earnings, as they continue to face refinancing pressure due to higher deposit rates," the report added.
This is because banks are unable to realise benefits of interest rate cuts on their cost of funds due to their shift to shorter tenor funds and the strong seasonal growth in March quarter, when banks refinance a large share of their liabilities at elevated deposit rates.
The report said some private sector banks, in a bid to maintain margins, have not cut their base rates at all, even though the RBI reduced the CRR by 200 bps during this period.
"The stunted transmission of monetary easing also stands in contrast to the government bond market, where the 10-year benchmark bond yield has come off by close to 100 bps compared to end-April 2012," says the report.
It said banks have been able to partly absorb the impact of reduced net interest margins due to a reduction in yield, following base rate cuts because they have started earning interest income from the non-earning cash reserves that were freed up.
The report notes that banks' structural shift to funding a large share of their assets with short-term deposits (50 percent of total deposits in March 2012) contributes to almost perennial refinancing pressure in the banking system.
Banks slashed deposit rates recently, as loan demand traditionally tapers off after the March rush and the April-June period is traditionally a slack season.
During the past five fiscals, loan growth in the April-June period has been taking place at only 2 percent, while deposits were accruing at under 3 percent.
"Therefore, lower deposit rates may not translate into a material reduction in the cost of funds in the near-term. In fact, during periods of high growth, banks are forced to increase deposit rates to garner funds to fuel balance sheet expansion," said the report.