Banks yet to fully pass on RBI rate hikes to customers, shows data

The RBI has been focusing on controlling liquidity conditions. In October, the RBI indicated that it was considering sales via open market operations (OMO) as a liquidity-absorbing tool

Indian banks are yet to fully pass on the central bank's policy rate increases to customers, a Moneycontrol analysis showed. The lack of monetary transmission in the system has long been a concern for the Indian central bank and has limited the impact of policy actions.

As per the Reserve Bank of India (RBI), the weighted average domestic term deposit rate of banks increased by 233 basis points (bps) and the weighted average lending rate on fresh loans rose by 196 bps in the current tightening cycle.

The corresponding increase in outstanding term deposit rates and outstanding lending rates of banks was even lower at 157 bps and 112 bps, respectively.

The weighted average domestic term deposit rate is an indicator of the average interest rate paid by banks on term deposits to customers. The weighted average lending rate is the interest rate charged by banks on all loans.

In October, RBI governor Shaktikanta Das said the 250 bps increase in the policy repo rate — currently 6.5 percent — wasn’t fully reflected in bank lending and deposit rates.

Why rate transmission is important

Actions to curb or increase demand are effective only when banks pass on the rate cues to customers. Effective rate transmission is crucial for the central bank’s inflation management.

“The transmission of the 250 bps increase in the policy repo rate to bank lending and deposit rates is still incomplete,” Das said during the October 2023 Monetary Policy Committee press conference. “Hence, the MPC decided to remain focused on withdrawing accommodation. The MPC remains highly alert and prepared to undertake timely policy measures, as necessary, to align inflation with the target and anchor inflation expectations.”

State Bank of India, the country’s largest lender, increased its term deposit rate to 6.5 percent in February from 5.5 percent in June 2022. According to the bank’s website, the lending rate rose to 8.75 percent in October from 7.70 percent in May 2022.

Punjab National Bank increased its external benchmark-linked lending rate (EBLR)-linked lending rate to 9.27 in December 2023 from an average of 7.42 percent in June 2022. PNB’s website showed that the average rate increased from 7.42 percent in May 2022 to 7.92 percent in June 2022 and 8.42 percent in August 2022. It jumped to 8.92 percent in October 2022 and peaked at 9.27 percent in February 2023.

Bank of Maharashtra’s marginal cost of funds-based lending rate on average stood at 8.34 percent, whereas the lender’s repo rate-linked lending rate stood at 9.30 percent. In the current tightening cycle, the lender’s data showed an average increase of 30 bps in rates.

What experts say

“The central bank has been giving signals to raise rates. But for banks, the rates have peaked and if they work on raising rates, it could affect their growth," said Vijay Singh Gaur, a financial expert.

A top executive with a private bank, who did not wish to be identified, said that banks are considering increasing rates in certain segments. "Personal loans and other similar segments are where we look at raising rates. Rest, we are carefully looking at market conditions," the banker said.

Liquidity management

The central bank has been focusing on controlling liquidity conditions. In October, the RBI indicated that it was considering sales via open market operations (OMO) as a liquidity-absorbing tool.

At the August MPC meeting, the RBI introduced the incremental cash reserve ratio (I-CRR) for banks, which temporarily removed Rs 1.1 lakh crore of liquidity. The subsequent phased removal of I-CRR over September and the first week of October ensured that liquidity conditions remained tight.

“The RBI has been actively intervening in the market with market operations, either by selling or buying bonds, to control liquidity and has kept the liquidity level tight to facilitate effective transmission of previous rate hikes,” said Gaura Sen Gupta, economist at IDFC First Bank.

The central bank also decided to increase the risk weight on consumer loans against the backdrop of aggressive growth in the unsecured segment by banks and NBFCs. In October, Das flagged this high growth in certain components of consumer credit.

Sen Gupta said the move to increase the risk weight on consumer loans would indirectly curb demand for personal loans.