18/03/2015 1:56 PM IST | Updated 15/07/2016 8:25 AM IST

Three Reasons Why Your Loans Have Not Become Cheaper

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DELHI, INDIA - DECEMBER 01: Tourists and indian people at a State Bank ATM cash machine with Gandhi likeness on December 01, 2012 in Delhi, Delhi, India. (Photo by EyesWideOpen/Getty Images)

The Reserve Bank of India cut its benchmark repo rate twice this year by 50 basis points and it was expected that banks will pass them on to customers by lowering their loan instalments or EMIs. Finance Minister Arun Jaitley had hoped this measure would help boost spending and drive growth.

That has not happened. Banks have not passed on the rate cut to customers so there has been no relief for your loan EMIs. State Bank of India and Bank of Baroda are among 43 of 47 lenders yet to lower base lending rates. And that also means that Jaitley's aim of 8.5 percent growth is not happening anytime soon. There are three main reasons for this:

1. Poor Liquidity: Indian banks are struggling with distressed loans which have ballooned to a record $67 billion. The banks were earlier let away with keeping just 5 percent of capital for such debt. That measure was put in place after the 2008 financial crisis to help corporations in a difficult economic phase. But now the Reserve Bank wants banks to set aside 15 percent in keeping with global Basel III standards that mandate higher provisions to deal with the risk of bad loans. This means banks are not really in a position to lower rates as they need more money to deal with their existing problems and requirements. Pubic sector banks are in a worse situation when it comes to bad loans, and they would first want to clean up their books.

2. Uncertain Lag Time: In a recent study, the International Monetary Fund (IMF) said that Indian banks are quick to adopt tightening of rates when RBI raises the repo rate, but are really slow in loosening rates. The paper said it takes 13 months for 80 percent of the change in the RBI’s benchmark rate to pass-through to interbank rate. Transmission to banks’ deposit and lending rates takes another 9.5 months and 18.8 months, respectively. "This hinders policy making by making it difficult to predict the effects of policy actions on the economy," it said. Bringing in more certainty in this process might lead to quicker response by banks to RBI's cuts.

3. High cost of funds: The cut in lending rate by 50 basis points is not enough for banks to start lending, say bankers. One option is to cut deposit rates, but banks are not able to do that because of competition from other savings instruments, such as post office accounts and savings plans, and equity markets. This fact, combined with rising bad loans and lower profitability means that banks are in a tight spot.

So when might lending rates fall? "It will depend on every banks liabilities profile," said Vaibhav Sanghavi, Managing Director, Ambit Investment Advisors Pvt Ltd., in an interview with HuffPost. "In my view, the banks would start passing as soon as their overall cost of funds decrease by repricing of fresh deposits which gets matured. It will happen but with a lag. In my view it may gradually start from April onwards." That's good news, because some analysts had predicted a longer timeline.

“Most banks may cut lending rates in the September quarter,” said Hatim Broachwala, a banking analyst at Nirmal Bang Institutional Equities Ltd. in Mumbai, said in this interview with Bloomberg. “Credit demand is also expected to improve by then.”