Reserve Bank of India (RBI) in its annual report for 2015-16 has raised concerns over weak monetary policy transmission, as the banks are loading a higher credit risk premia on their new customers to save their profitability. In response to the reduction in policy repo rate by 150 basis points during January 15, 2015, through April 5, 2016, it said the median base rate of banks declined by 60 basis points as against a higher decline of 92 bps in median term deposit rates reflecting banks' preference to protect profitability in the wake of deteriorating asset quality and higher provisioning.
The report stated that so far in financial year 2016-17, there has hardly been any transmission of a reduction in the policy rate to the actual lending rates charged to customers. While the cost of funding by banks has declined somewhat, leading to a decline in shorter maturity marginal cost of funds based lending rate (MCLR), there has been an increase in the term premia in respect of term loans of one year and above, thereby attenuating the transmission to actual lending rates charged to customers. Moreover, banks may have been loading a higher credit risk premia on their new customers in order to attain their desired return on net worth in a rising Non-Performing Assets (NPA) environment.
RBI said that banks are charging a higher strategic risk premia on their riskier loans as part of their business strategy to reorient their lending operations towards less risky activities. The consequent rise in the spread is reflected in a near unchanged weighted average lending rate (WALR) in respect of both outstanding and fresh rupee loans during 2016-17 up to June. It further said that under MCLR the transmission to WALR is expected to improve on the assumption that the marginal cost of funds is more sensitive to changes in the policy rate than the average cost of funds.