Three senior bankers told Mint that a reduction of interest rates would not be immediate because of the paucity of liquidity, at a time when lenders were fearful of losing customers and did not want to lower deposit rates. Among several measures, the regulator on Friday announced a three-year dollar swap of $10 billion, barely a month after a six-month swap of $5 billion. It has also conducted open market operations or OMOs and variable rate repo (VRR) auctions to infuse liquidity.
Despite RBI’s moves, liquidity has stayed in deficit since mid-December. After peaking at ₹3.3 trillion on 23 January, deficit cooled to ₹2.1 trillion as on 20 February, Bloomberg data showed.
“The Reserve Bank of India’s move to do a rupee swap is a move in the right direction. Another round of similar quantum would be required in a similar or alternative structure,” said a top executive at a private sector bank. “Bank credit growth has to pick up to over 13% from the current 11.5% for the economy to pick up pace, and for that, RBI must ensure sufficient liquidity.”
Credit growth and deposit trends
Non-food credit growth slipped to just over 11% year-on-year (y-o-y), from 16.3% in early February last year, RBI data showed. Non-food credit is bank credit after adjusting for loans given to the Food Corp. of India (FCI). While the gap between credit and deposit has narrowed, there is still a deficit in the banking system liquidity, making it harder for banks to grow credit faster.
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Interestingly, soon after RBI lowered repo rate by 25 bps, HDFC Bank and Uco Bank raised their marginal cost of funds-based lending rate (MCLR)by 5 basis points (bps). Loans to industry are based on MCLR, an internal metric linked to deposit rates, and an increase in MCLR means these loans will see an increase in interest rate.
While a hike in MCLR runs counter to what RBI is trying to signal to the market, bankers say this reflects the cost of funds at the bank level.
“Banks are increasing MCLR based on their cost of funds,” said the chief executive of a public sector bank. “Even as RBI has cut the repo rate, banks may not be able to cut deposit rates immediately.”
Mint reported on 14 February that banks feel that the recent 25 basis point (bps) rate cut by the RBI might not be enough to lower deposit rates, which is necessary to reduce lending rates for more than a third of their borrowers, mostly corporates, and at least another cut is needed for action on this front.
“Liquidity is a problem. Let us accept that,” said the chief financial officer of a large bank. “Now that the RBI has come up with a cut in repo and is infusing liquidity, it will ease, but the question is whether banks will be able to pass on the benefits of the rate cut.”
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Banking strategies and future outlook
The banker said that while a large portion of the asset side or loans will reprice after the rate cut, liabilities or deposits will take much longer, leading to difficulty in transmission. Bankers said that deposits typically take about three quarters to reprice after their rates are lowered. That is because, unlike loans, only fresh deposits are raised at the new rates while existing ones continue to earn old rates till maturity.
Outstanding term deposits earned a weighted average interest of 7% in December, whereas fresh deposits earned 6.57% in the same month, showed data from RBI.
“Banks that are hiking MCLR rates are doing so to minimize the impact of the rate cut on their net interest margins,” said the banker. However, he added that RBI’s move to delay the liquidity coverage ratio norms at least till 31 March 2026 will provide some relief.
Estimates by Fitch suggest that net interest margins of banks will decline by about 10 bps on average in FY26, following the 25-bps repo rate cut on 7 February, and the additional 25 bps cut that Fitch expects in FY26.
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Given such an environment where liquidity is tight and deposit growth is constrained, bankers caution that credit growth will also slow down. Axis Bank does not expect deposit or credit growth to move from 11-12% in FY26, chief executive Amitabh Choudhary said in the bank’s Q3 earnings call.
“Today, we have a situation where there is a liquidity problem,” said Madan Sabnavis, chief economist, Bank of Baroda. “One of the factors is that our deposits are still not growing and that could be because people are prioritizing consumption over savings.”
Sabnavis said that one cannot say that mutual funds are taking away bank deposits because their AUM (assets under management also declined in January. As per data from AMFI, a nodal association of mutual funds in India, AUM of equity mutual funds shrunk ₹1.1 trillion between December and January.
“Fundamentally, people are saving less,” he said.
