RBI cuts repo rate by 50 bps

RBI in a surprise move cut repo rate by 50 bps due to lower than expected inflation. This will put pressure on banks to cut base rates by at least 30 bps immediately. It is expected of banks to announce base rate cuts over the next 1-2days. The focus of the governor’s speech was on transmission of policy rates and reiterated that he would like banks to compute rates based on marginal cost. He also said that the government should also help in making it easier for banks to transmit policy rate cuts by various ways such as cutting rates on small savings. NBFCs with a high proportion of borrowings from banks will benefit from base rate cuts by banks.

Key measures

• RBI cut the repo rate by 50bps. Bond yields have corrected from 7.8% in end June to 7.6% currently. Banks will have the benefit of booking mark to market gains on their AFS bond books following the fall in yields. That benefit will be offset by pressure on banks to cut base rates.

• PNB, BOI, Union and Axis have more leeway to cut base rates compared to SBI and BoB as SBI and BoB banks have a lower duration AFS portfolio. RBI expects banks to transmit monetary policy rate cuts of 125 bps since Jan 2015. Banks have cut base rates by 30 bps on an average. It is believed that there will be pressure on them to cut by at least 50-60bps more. As such, bond gains may not be enough to wipe out the negative impact of base rate cuts for most banks.

• RBI has announced reduction in SLR by 0.25% every quarter to 19% by March 2017 from the current 21.5%.

• The securities that banks can hold under HTM (Held to Maturity) have been reduced to 21.5% from current 22%. After this cut the proportion of HTM has been aligned to the level of SLR which is also 21.5%. The lower proportion of HTM will be positive for banks in the current environment of falling rates as banks will have a higher proportion of securities which they will mark to market. From now on HTM and SLR will move in tandem.

• RBI has now mandated banks to disclose divergences from RBI norms that RBI auditors find in banks’ accounts on asset / NPL classification and provisioning. These divergences have to be reported in notes to accounts where they exceed a specified threshold. Separate guidelines will be issued later. So banks will have to disclose where RBI has found flaws in their NPL classification and income recognition – this will be an important disclosure and will have an impact on stock prices.

• RBI has said that they will lower risk weights on affordable housing loans to individuals. Detailed guidelines will be issued later. This is positive for housing financiers that have a large proportion of affordable housing loans – LICHF, HDFC, SBI, ICICI Bank (in that order). It is not known if RBI changes its definition of affordable housing. Currently for the purpose of risk weights, all housing loans upto Rs2M with LTV of 90% or less qualify for a low 50% risk weight. For loans above Rs2M, a risk weight of 50% is allowed only if the LTV is 80% or less. (Notably the definition of affordable housing for the purpose of issuing SLR/priority is different from the definition used while calculating risk weights. For the purpose of issuing long term bonds, RBI defines affordable housing as loans of Rs4M in non-metro towns with value of property not exceeding Rs5M and Rs5M in metros with value of property not exceeding Rs6.5M). We do not know which definition RBI will use for these guidelines but most likely the former.