Banking Central| The RBI’s rate cut bonanza: What next for banks?

Sanjay Malhotra-led RBI's growth boost will benefit the economy if banks step up to the task .

The Reserve Bank of India’s monetary policy committee (MPC) on June 6 delivered a bold 50-basis points (bps) repo rate cut, the third consecutive reduction since February, bringing it down to 5.5 percent.

Coupled with a 100 bps cut in the cash reserve ratio (CRR) to 3 percent, the move will unleash Rs 2.5 lakh crore of lendable resources into the banking system. The central bank’s shift to a “neutral” stance signals a clear intent to spur growth in a world clouded by global uncertainties — US trade tariffs to geopolitical tensions.

With inflation dropping to a six-year low of 3.16 percent in April and GDP growth projected at a steady 6.5 percent for FY26, the stage seems set for a credit-fuelled growth bonanza.

But here’s the big question: can banks deploy this liquidity profitably or will structural bottlenecks turn this windfall into a missed opportunity?

The big liquidity push

The RBI’s aggressive easing is a calculated response to a sluggish credit cycle. Non-food bank credit growth has decelerated to 9.6 percent year-on-year as of May 16, a sharp drop from 16.3 percent in FY24 and 10.9 percent in FY25.

The CRR cut, to be implemented in four 25 bps tranches through November, aims to reverse the trend by freeing up capital that banks can lend rather than park interest-free with the RBI. Lowering the repo rate also reduces borrowing costs, with external benchmark lending rates (EBLR) and marginal cost of funds-based lending rates (MCLR) expected to fall by 50 bps, directly benefiting borrowers.

Home loan EMIs, for instance, could see a significant drop, potentially spurring demand in real estate, a sector critical to economic multipliers such as construction and consumer spending.

Industry voices argue that lower interest costs will incentivise corporate investment, stabilising profits across sectors where interest-to-turnover ratios range from 2-3 percent for non-financial firms to 10 percent for capital-intensive industries.

Deposits, asset quality concerns

The banks will have to carefully translate this liquidity bonanza to profitable credit deployment. There are challenges.

Banking Central

Banks face a structural mismatch between credit and deposit growth. As of December 2024, the credit-deposit ratio stood at 81.84 percent, reflecting tight liquidity conditions. High retail deposit costs and limited deposit mobilisation, exacerbated by attractive small savings schemes, have constrained banks’ ability to grow their deposit base.

The weighted average rate on fresh term deposits dropped to 6.3 percent in April, down 35 bps from the year-ago period but lending rates on fresh loans only declined by 10 bps to 9.26 percent. This sluggish transmission suggests banks are hesitant to pass on rate cuts fully, wary of squeezing their net interest margins (NIMs).

While the CRR cut offsets some pressure on NIMs, banks’ profitability hinges on their ability to lend at scale without compromising asset quality, Sujan Hajra of Anand Rathi Group said.

For one, asset quality risks loom large, particularly in retail and MSME segments. Non-banking financial companies (NBFCs), vital for last-mile credit delivery, are grappling with tight liquidity and rising gross non-performing assets (GNPAs), though still at manageable levels. The recent RBI’s annual report highlights healthy bank balance sheets, but incremental credit flow remains weak, with year-to-date non-food credit outstanding declining as of May 2025.

This cautious lending behaviour stems from lingering concerns over loan repricing and potential defaults, especially in sectors exposed to global trade disruptions. US President Donald Trump’s tariff policies, for instance, threaten export-oriented industries, which could dampen private capex and loan demand.

ICRA forecasts bank credit growth at a modest 10.4-11.3 percent for FY26, with downside risks if asset quality deteriorates.

The RBI’s liquidity measures, including Rs 6.8 lakh crore injected through open market operations and forex swaps since January, have eased systemic liquidity from a Rs 2 lakh crore deficit to Rs 1.6 lakh crore by March. However, durable liquidity alone isn’t enough. Effective transmission of rate cuts to end borrowers remains a sticking point.

While the rate cut could kickstart credit growth, banks and NBFCs must prioritise passing on benefits to retail and SME segments. Without robust transmission, the RBI’s efforts risk being diluted, leaving consumer spending and investment stagnant.

Some challenges persist

Global headwinds add another layer of complexity. The RBI projects CPI inflation at 3.7 percent for FY26, supported by a normal monsoon and falling food prices, but rising fuel costs and gold prices could exert upward pressure.

If inflation ticks up, MPC’s the neutral stance gives it room to pause or reverse course, potentially disrupting banks’ lending plans.

Moreover, foreign portfolio investment dropped to $1.7 billion in 2024-25 and net FDI has moderated, signalling caution among foreign investors amid global volatility. A weaker rupee, while aiding exporters, could inflate import costs, squeezing corporate margins and loan repayment capacity.

The RBI’s rate cut and CRR reduction are a shot in the arm for India’s growth story, poised to sustain its status as the fastest-growing major economy.

Banks, however, have to deal with tight deposit growth, asset quality risks, and global uncertainties while translating the liquidity boost into profitable credit deployment. The bond market has already priced in lower yields, softening by nearly 100 basis points in four months, signalling optimism.

The real test lies in spurring domestic demand to counter external shocks. If banks fail to lend boldly and efficiently, this growth bonanza could fizzle out, leaving India’s economic engine idling when it needs to roar.

(Banking Central is a weekly column that keeps a close watch on and connects the dots regarding the sector's most important events for readers.)