Frontloaded rate cut and CRR cut to push banks to lend 

In our view, the reversal of stance to neutral, appears to be a strong signal of a pause, especially when combined with the unexpected CRR cut. As of now, we expect rates to be unchanged in the August 2025 policy review.

Unexpected scale of monetary loosening offsets two negative factors for banks

The constraints in deposit mobilization and high cost of retail deposits have been one of the factors weighing on decision-making of banks to push credit growth. Furthermore, a fear of downward repricing of the fresh loans upon rate cuts in future, also weighed upon the lending decisions of the banks. With a 50-bps cut in the repo rate to 5.5%, a 100-bps cut in CRR to 3.0% and a change in stance to Neutral, the MPC has tried to address both the issues of liquidity and concern on further downward re-pricing of loans in future.

Further, with reassuring statements on abating credit risk in unsecured loan segments, the RBI has now put the ball in the court of the lenders to push for credit growth. We also expect the credit quality environment in retail loans to start improving from H2 FY26, as some of the corrective action taken by the lenders on underwriting retail loans over the last 12 months plays out.

Long-term bond yields bottom out, short-term yields to decline amid surplus liquidity

With the change in policy stance to neutral, the headroom for further cut in policy rates remain limited and uncertain; accordingly, the yield on benchmark 10-Year G-sec rose by 3-4 bps compared to the opening levels for the day. However, with surplus liquidity conditions and sharp cut of 50-bps in policy rates, we expect the rates on short-term money market instruments like treasury bills, commercial papers and certificate of deposits to decline by 30-40 bps over the pre-policy levels. With a cumulative cut of 100bps in repo rate and a decline of more than 150 bps in overnight rates, the rates on money market instruments have already moderated by 130-150 bps over the peak levels witnessed in Q4FY25.

The yield on long-term corporate bonds has also declined by 80-100 bps depending on the rating category and remains significantly competitive compared to bank lending rates with their MCLRs at 9% level. With expectations of limited decline in long-term bond yields, we expect the corporate bond issues to grow further in FY26 from the record high levels of almost Rs 11 trillion issuances during FY25.

Margins to be a pain point for banks; expect further cut in saving deposit rates

Since the beginning of this rate cut cycle, the weighted average lending rate on bank loans declined to 9.70% in April 2025 from 9.87% in January 2025, whereas the weighted average cost of term deposit declined by just 1 bp to 7.01% in April 2025 from 7.02% in January 2025. With steep cuts in repo rate, the loans linked to external benchmark are expected to further reprice downwards, whereas the deposit base will reprice with a lag of at least a few quarters. To address this pressure on interest margins, the banks have already taken a cut in their term deposit rates while few have also started cutting the saving accounts rates. Following the policy action, we can expect more banks to cut deposit rates in the near future. While today’s cut in CRR will support the net interest margins for the banks, however as it comes into effect from September 2025 onwards, the benefit is expected to be limited to 3-4 bps for FY26.

ICRA projects banking sector credit growth at 10.4-11.2% for FY2026, similar to FY25; an uncertain outlook for private capex amidst the tariff-related uncertainties may prevent a sharper acceleration in credit growth despite the RBI’s enabling steps today. This coupled with the pressure on margins could translate into muted earning growth for banks. A likely higher treasury profits on bond portfolio coupled with ability to work around the product-mix will be a key supporting factor for the growth of earnings.