The calibrated normalisation of surplus liquidity and robust credit growth have strengthened transmission during the current tightening phase, although it is still not complete, according to a report by the Reserve Bank of India (RBI).
The report highlighted that the pace of increase in deposit rates (term deposits and savings account deposits taken together) has lagged behind the pace of increase in lending rates so far.
While lending rates started to rise from May 2022 in response to the incremental increase in the policy repo rate, the savings deposit rates of banks – which are a third of total deposits – have remained almost unchanged.
However, the increase in term deposit rates in the current tightening cycle has exceeded that in lending rates, the report said.
‘The transmission of rates to term deposits has been robust, while savings deposit rates have exhibited ‘rigidity’,’ the report said.
Over the period from May 2022 to October 2023, Scheduled Commercial Banks (SCBs) adjusted their repo-linked benchmark rates upward by 250 basis points, mirroring the cumulative hike in the repo rate. However, the one-year median marginal cost of funds-based lending rate (MCLR) increased by a relatively lower magnitude of 152 basis points, reflecting trends in banks’ cost of borrowings.
Meanwhile, the Weighted Average Domestic Term Deposit Rate (WADTDR) for fresh deposits increased by 229 basis points from May 2022 to September 2023. In the initial stages of the tightening cycle, banks raised bulk term deposit rates more than retail term deposit rates. However, in the second half of FY 2022-23, the increase in retail deposit rates surpassed that of bulk deposit rates. The WADTDR for fresh retail deposits increased by 164 basis points compared to 269 basis points for fresh bulk deposits during the same period. The transmission to WADTDR on outstanding deposits was lower at 166 basis points.
The Weighted Average Lending Rate (WALR) on fresh rupee loans increased by 187 basis points, and that on outstanding loans rose by 111 basis points during May 2022 to September 2023. The report said that the increase in the share of outstanding floating-rate loans linked to external benchmarks, especially the policy repo rate, contributed to this transmission. The choice of the policy repo rate as the benchmark for loan pricing has been prevalent among most banks, leading to an increase in the proportion of loans in the above 8 per cent interest rate range.
Additionally, the report said that the increase in WALRs on fresh rupee loans was higher for public sector banks (PSBs) compared to private banks (PvBs). However, the transmission to WALR on outstanding loans was relatively more significant for PvBs than PSBs. This was attributed to the higher proportion of outstanding floating-rate loans linked to external benchmark rates in PvBs, fostering a more substantial pass-through to lending rates.
The study also highlights that foreign banks experienced the maximum transmission to both lending and deposit rates. This is attributed to the preponderance of their loans being External Benchmark Lending Rate (EBLR)-linked on the lending side and a higher share of low-cost and lower-duration wholesale deposits on the liabilities side. These factors facilitate a faster adjustment in interest rates for foreign banks, the report said.
The report concluded that lending rates exhibit a relatively faster change in response to an increase in the policy repo rate compared to a decrease. Conversely, for deposits, the pass-through is quicker during the easing phase than the tightening phase.