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Central banks worldwide have been nudging interest rates up to control inflation. So has been the case in India, with the Reserve Bank of India (RBI) raising the repo rate or the interest rate at which it lends to banks.

This has turned out to be a boon for commercial banks. However, while they have increased interest rates on lending very quickly, they have been taking it slow when it comes to raising interest rates on deposits.

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In sweet spot

In April, at the beginning of FY23, the weighted average lending rate charged by commercial banks on fresh rupee loans stood at 7.51%. By August, the latest data available, this had jumped by 82 basis points (bps) to 8.33%. One basis point is 0.01%.

When it comes to the weighted average lending rate on outstanding rupee loans, the interest rate charged has gone from 8.72% in April to 9.13% in August, a jump of 41bps.

Anecdotal evidence suggests that loan rates increased further in September after RBI raised the repo rate.

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In comparison, the weighted average term deposit rate on outstanding rupee term deposits of commercial banks has increased from 5.03% in April to 5.29% in August, an increase of a much lower 26bps.

Banks have been able to do this until recently, as they had more deposits than they could lend. In October last year, the credit-deposit ratio of banks was around 70%, which meant banks had been lending around 70 out of every 100 they took on as deposits. However, as of 7 October, the ratio jumped to 74.5%, meaning the banks are now lending nearly three-fourths of their deposits. This is the highest the credit-deposit ratio has been for a while.

This means banks had enough deposits to fund the jump in lending growth that happened over the last few months. As of 7 October, the annual credit growth of commercial banks stood at 16.75%, while the deposit growth was at a more sober 9.63%, albeit on a higher base.

This allowed banks to quickly raise interest rates on lending under the garb that RBI raised the repo rate while going slow on increasing deposit rates. This ensured that the margin between the interest rate at which banks lend and the rate they borrow had gone up, boosting their overall profit.

This can be seen in the September quarter earnings of banks. Take the case of ICICI Bank. The yield on their loans rose from 8.12% in the June quarter to 8.63% in the three months ended 30 September. In comparison, the cost of deposits increased marginally from 3.46% to 3.55%. This has helped push up the profits of the bank. Something similar has happened with Canara Bank as well. The cost of deposits has gone up from 3.99% to 4.09%, while the yield on loans has grown from 7.03% to 7.24%.

The question is whether this will continue. Fresh data and anecdotal evidence suggest that the deposit rates are going up faster now than over the last few months. Data from the RBI suggests that as of 14 October, the term deposit rate for deposits of more than one year period was in the range of 5.45-6.10%. In mid-August, it had been in the range of 5.30-5.75%, which implies a jump of 35bps at the upper level. These rates should go up further in the coming months, implying that the repricing of deposits will now happen at a faster pace assuming the credit growth remains strong.

The icing on the cake in the form of deposit rates growing slower than interest rates on lending may not be available to banks for much longer. At best, banks can benefit from this during the December quarter.

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