The Reserve Bank of India (RBI) has always bemoaned the lack of transmission of its policy rate cuts on to banks’ lending rates.

A big enabler of transmission is the movement of deposit rates, which is the biggest source of funding for banks. Unlike non-bank peers, Indian banks get more than 80% of their funding from public deposits. In that, retail term deposits are a growing segment.

Since a bank’s earnings depend on how much margin it makes over its deposit rates, sticky rates on deposits mean it cannot lower lending rates for its borrowers.

As per the latest data from the central bank, weighted average term deposit rate for domestic deposits has risen by a marginal three basis points in August. A basis point is 0.01%.

But that is not the worrying sign. What is of concern is that the 135 basis point cut in policy rates since February hasn’t translated into a sharp fall in deposit rates.

But what has happened this time to banks, which normally are too eager to pass on policy rate cuts to depositors?

One explanation is that banks have become cautious after having experienced a fight to get deposits. “Last year, we saw credit exceeding deposit growth and the RBI had to intervene and do OMO (open market operations). So, this time, banks have been very cautious in lowering rates," said Madan Sabnavis, chief economist at CARE Ratings Ltd.

Graphic: Santosh Sharma/Mint
Graphic: Santosh Sharma/Mint


Another explanation is that household savings have not been growing as they were, and avenues for parking savings have increased. The government is absorbing almost all of household savings and little is left for the private sector.

Also, banks compete with government savings schemes, mutual funds and other financial products for household savings. Interest rates on government savings schemes have not fallen much in the past one year.

To be sure, banks have begun cutting deposit rates since September. Typically, deposit rates precede lending rates but this time, it could be the other way around. RBI has mandated banks to link interest rates on retail and small business loans to an external benchmark from October. “Interest rates on fresh retail and SME loans have now come down. So, banks will be forced to cut deposit rates as well," said Sabnavis.

Analysts at Kotak Securities Ltd said that the pressure to mobilize deposits has now eased, making it easier for banks to cut rates.

“Deposit growth at 10% yoy levels in second quarter of FY20 (similar to past two quarters) is broadly similar to pre-demonetization levels. With loan growth moderating to around 10% yoy, pressure on deposit mobilization will likely ease," it said in a note.

Deposit rates are likely to come down soon enough. Ergo, lending rates are not far behind.


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