Repo rate relief? Big surprise for big business as banks dither on lowering lending rates

The development comes on the back of the first repo rate cut this month by the Reserve Bank of India (RBI) in five years—of 25 basis points (bps)—and the central government’s reported hawk-eye on banks to follow suit on their own lending rates. (One bps is one-hundredth of a percentage point.)

One big reason for the hesitation to cut deposit rates (a precursor to a lending rate cut) is the potential outflow of money at a time credit growth is expected to pick up. “There is a challenge for banks because the repo rate cut of 25 bps will anyway hit net interest margin (NIM) and net interest income (NII)," said Ashok Chandra, chief executive of Punjab National Bank (PNB).

To be sure, estimates by Fitch suggest that Indian banks’ NIM will fall by about 10 bps on average in the financial year ending March 2026 following the 25-bps repo rate cut on 7 February, and the additional 25-bps cut that it expects in FY26.

Also read | RBI MPC slashes repo rate after 5 years. Is another cut likely this year?

Why banks can’t cut rates

Banks feel that the rate cut by the RBI might not be enough to lower deposit rates, which is a necessary precondition to scaling down lending rates for more than one-third of their borrowers, comprising mostly corporates, and at least another cut is needed for action on this front.

Banks give out loans to industry based on a benchmark called marginal cost of funds or MCLR, which is an internal metric that is linked to their deposit rates.

As of September 2024, 37% of all floating rate loans were linked to MCLR, per data from RBI. For this segment, interest rates on loans can go down only once the MCLR changes, which in turn can only happen after banks revise deposit rates downwards.

Bankers, though, don’t see this happening.

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What banks are saying

Chandra said PNB is not looking to lower deposit rates right now and, therefore, does not see an immediate change in MCLR. “However, every bank is waiting for the meeting of their ALCO (asset liability committee) to take the final call," he said. The ALCO, comprising senior executives of a bank, is responsible for monitoring the current market risk and taking a call on its interest rates.

Pralay Mondal, chief executive of CSB Bank, said that transmission to MCLR rates may not happen immediately and the primary reason is that it is linked to marginal cost of deposit.

“The months of January, February and March are months when lending picks up for banks. Therefore, the demand for incremental deposit goes up, which prevents the deposit rate from going down, especially when system liquidity is still not quite comfortable," said Mondal, adding that MCLR is a formula-driven benchmark and it would be a decision taken by the asset liability committee of individual banks.

Also read | Personal loan growth slows, but banks haven't given up on it

Analysts agree, pointing to two reasons why banks will not be able to reduce deposit rates right now. Saswata Guha, senior director, financial institutions (banks), Fitch Ratings said that first, liquidity is still in deficit even though it has eased, and second, the credit-deposit ratio of banks has risen and is likely to remain so as loan growth still exceeds deposit growth for most banks. “That is also going to prevent banks from cutting deposit rates, preventing immediate transmission," said Guha.

At the same time, CSB Bank’s Mondal said that if there is another rate cut of equivalent size in April, then MCLR rates will definitely be lowered.

Meanwhile, the government is also tracking banks’ progress in passing on the rate cuts to borrowers, the Economic Times reported on 10 February. Citing an unnamed senior government official, the report added the Centre will hold discussions with banks if such transmission is not reflected in the next few weeks.

Long wait

To be sure, retail and small business loans are not linked to MCLR. They are instead linked to the EBLR, or external benchmark-based lending rate, which is linked to benchmarks like the RBI repo rate, and is used to price loans. While banks said they will lower rates on loans linked to the EBLR soon, corporate borrowers would have to wait longer.

Also read | The plague of souring small loans is back

Corporates have been reluctant borrowers in the past few years, instead using their internal accruals for business expansion. Loans to industries grew 7.2% in 2024, as against 8% in 2023. In comparison, credit to retail borrowers has grown 12% in 2024, despite having a larger base than outstanding corporate loans.

At the end of 2024, outstanding corporate and retail loans were at ₹38.5 trillion and ₹57.9 trillion, respectively.

The median MCLR rate for banks stood at 9% in January, as per RBI data, up 20 bps in the past one year. Meanwhile, the weighted average term deposit rate on fresh deposits increased 8 bps in the past year and stood at 6.57% in December. Lenders were troubled by a deposit crunch in 2024, as credit growth outstripped growth in deposits.

On 7 February, the monetary policy committee (MPC) of the central bank RBI lowered the repo rate by 25 basis points (bps) to 6.25%, its first rate cut in five years, on the back of softer retail inflation.