The 10-year G-sec yield, a decent indicator of interest rate movement in the economy, is at around 7.13 per cent. 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 is showing an upward trend, it also reflects the high cost of borrowing for the government. On the contrary, individuals looking to borrow from banks are being offered loans around 7 per cent or even lower. Does that mean the cost of funds for individuals is less than what the government incurs on raising funds?
V Swaminathan, executive chairman, Andromedaloans.com and Apnapaisa.com takes a deep down approach to untangle the mystery and how individual borrowers may stand to benefit because of this anomaly.
V Swaminathan on the borrowing scenario in the country
For all of us who have taken loans for any particular purpose have gone through a hard time understanding the intricacies of the interest charged or other charges that are applied on a loan repayment. A loan given to an individual borrower is a result of multiple financial instruments like bonds, deposits, interest earnings and public debt, being utilized by large financial institutions and a part of it is used by these institutions to provide loans to their retail customers.
Every lender has their own criteria and an internal mechanism to set the basic interest rate structure added with a spread which is charged from a borrower during the repayment of the loan. Nowadays, whenever we 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 was earlier which sounds good to a borrower and it is good.
Over the past two and a half years, the government has tried its best to keep the rates as minimum as possible so that the nation can come back to its pace post pandemic. But at the same time, if we think of the overall interest rate mechanism prevailing in the country, the entire scenario is different than what it seems to be.
If we secure a 10-year deposit with the largest bank in the country, the State Bank of India (SBI), the rate we get is around 5.50% per annum, which means that the bank is borrowing money from retail customers for 10 years at 5.50%. On the other hand, when an individual borrows for 10 years the interest rate being charged is 6.50% which is even backed by a security that is the home as collateral for which you are taking the loan, and the rate is evidently higher than 5.50%.
Cost to borrowers vs. Cost of the Government
Talking about the basic premise of economics which suggests that the better the profile, lower is the cost of borrowing and vice versa. Going forth, it may seem like stating the obvious, but we as individuals are not the SBI or any other institution and have to pay more for borrowing money from them. As per the recent slab, the state governments in India raise money through various ways, majorly with primary issuances of bonds at approximately 7.20% – 7.30%, and a 10-year return on central government securities, the highest credit quality instrument in the country, is also around 7.15%. This might sound a little odd but the central government is borrowing money at approximately 7.15% for a period of 10 years. And that is where the anomaly starts: we the people are borrowing at 6.50% and the highest authorities in the country are borrowing at 7.15% or 7.25%.
How can this be rectified?
India’s central bank — the Reserve Bank of India (RBI) reduced the interest rates during the pandemic. That led to a low deposit and lending rates in the banking system. A few banks have increased their deposit and loan rates, but only by a margin. With inflation being on the higher side and as the economic growth has resumed, we are at the threshold of the RBI increasing the interest rates. There might be several reasons but we do have a lopsided interest rate structure as of today. One can say that the issue is if people like us can borrow at a cost lower than the government. It is good for us when we are borrowing but it is unfair when we are depositing with the banks.
The loans distributed by the banks come from the money borrowed from the base of depositors. As per a bank’s internal system, they may lend after accounting for their costs and margin. Considering the level of inflation and the time quotient of the money made by the depositors, the interest rates being charged should be positive, keeping the inflation cost covered. Now, as and when the RBI hikes interest rates, this would reduce the gap for depositors and borrowers.
As banks today have surplus money due to the liquidity infused by the RBI during the pandemic, the banks would obviously disburse the existing extra cash than increase the deposit rates to a meaningful extent and will in turn earn fresh money from the consumers. To keep a check the RBI will have to reduce the excess liquidity circulating around in the banking system. For doing so, in the last MPC review, the RBI has announced that it will be done over “multiple years in a non-disruptive manner”.
What does this correction of rate mean to a borrower?
If someone has taken a loan at a floating rate of interest, the interest cost will move up, but only at regular intervals over a period of time. Over the years, the RBI has taken a policy stand that prevents the benchmark for floating interest rates are not under the control of banks. If the benchmark is the repo rate which is currently prevailing at 4.40%, it will keep moving up as and when the RBI hikes the repo rate. At the same time, the government’s cost of borrowing will also move up to an extent. However, it will not move up as much, as it has already been done in anticipation. The opportunity that individuals can avail home loans at cheaper rates than the government’s borrowing cost will prevail for a while, till the process of rectification gets completed by the RBI and the government itself.