Why is the cost of borrowing higher than the interest rate on deposits in India?

The 10-year G-sec yield, a good indicator of the evolution of interest rates in the economy, is around 7.13%. This is nearly 133 basis points higher than the levels seen last year at the same time. While it shows that the interest rate scenario shows an upward trend, it also reflects the high cost of borrowing for the government. On the contrary, individuals looking to borrow from banks are offered loans of around 7% or even less. Does this mean that the cost of funds for individuals is less than what the government incurs to raise funds?

V Swaminathan, Executive Chairman, Andromedaloans.com and Apnapaisa.com takes an in-depth approach to unraveling the mystery and how individual borrowers can benefit from this anomaly.

V Swaminathan on In-Country Borrowing Scenario

For all of us who have taken out loans for a specific purpose, we have struggled to understand the intricacies of interest charged or other fees applied to repaying a loan. A loan granted to an individual borrower is the result of several financial instruments such as bonds, deposits, interest income and public debt, used by large financial institutions and a part of it is used by these institutions to provide loans to their retail customers.

Each lender has its own criteria and internal mechanism to set the base interest rate structure plus a spread that is charged to the borrower when repaying the loan. These days, whenever you see a loan advertisement whether online or offline, offering a home loan at 6.50% per annum, it is obvious that the rate seems lower than it previously was what sounds good to a borrower and that is fine.

Over the past two and a half years, the government has done its best to keep rates as low as possible so that the country can get back on its feet after the pandemic. But at the same time, if we think about the overall interest rate mechanism prevailing in the country, the whole scenario is different than it seems.

If we get a 10 year deposit from the largest bank in the country, the State Bank of India (SBI), the rate we get is around 5.50% per annum, which means the bank is borrowing money to individual customers for 10 years. at 5.50%. On the other hand, when an individual borrows for 10 years, the interest rate applied is 6.50%, which is even backed by a title which is the house as collateral for which you take out the loan, and the rate is obviously greater than 5.50%.

Cost to borrowers versus cost to government

Let’s talk about the basic principle of economics which suggests that the better the profile, the lower the cost of borrowing and vice versa. Going forward, it may seem like a no-brainer, but we as individuals are not the SBI or any other institution and have to pay more to borrow money from them. According to the recent installment, Indian state governments are raising funds in different ways, mainly with primary bond issues at around 7.20% – 7.30%, and 10-year yield of central government securities, l highest credit quality instrument in the country. , is also about 7.15%. It may sound a bit strange, but the central government borrows money at around 7.15% over a 10-year period. And this is where the anomaly begins: we the people are borrowing at 6.50% and the highest authorities in the land are borrowing at 7.15% or 7.25%.

How can this be rectified?

India’s central bank – the Reserve Bank of India (RBI) has cut interest rates during the pandemic. This has led to low deposit and lending rates in the banking system. A few banks raised their deposit and lending rates, but only by a margin. With inflation on the rise and economic growth having resumed, we are on the threshold of the RBI raising interest rates. There could be many reasons, but we have an unbalanced interest rate structure to date. Arguably, the question is whether people like us can borrow at a lower cost than the government. It’s good for us when we borrow, but it’s unfair when we deposit with banks.

Loans distributed by banks come from money borrowed from the depositors base. According to a bank’s internal system, it can lend after accounting for its costs and margin. Given the level of inflation and the time quotient of the money earned by depositors, the interest rates applied must be positive, which makes it possible to cover the cost of inflation. Now, as the RBI raises interest rates, it would narrow the gap between depositors and borrowers.

As the banks today have a surplus of money due to the liquidity infused by the RBI during the pandemic, the banks would obviously shell out the existing extra money to raise deposit rates significantly and in turn earn fresh money from consumers. To maintain control, the RBI will have to reduce the excess liquidity circulating in the banking system. To do this, during the last MPC review, the RBI announced that it would be done over “several years in a non-disruptive manner”.

What does this rate correction mean for a borrower?

If someone has taken out a variable interest rate loan, the interest cost will increase, but only at regular intervals over a period of time. Over the years, the RBI has taken a policy stance that prevents floating benchmark interest rates from being out of the control of banks. If the benchmark is the repo rate currently prevailing at 4.40%, it will continue to rise as the RBI raises the repo rate. At the same time, the government’s borrowing cost will also increase to some extent. However, it will not rise as much, as has already been done in anticipation. The ability for individuals to avail home loans at rates lower than the government’s cost of borrowing will prevail for some time until the rectification process is completed by the RBI and the government itself.

Stephen V. Lee