Public sector banks have been slow to pass on interest rate changes to borrowers, limiting the impact of RBI's past policies. With the Reserve Bank of India set to meet on October 7, 2026, amid inflation concerns, the speed at which banks adjust lending and deposit rates remains a key monitorable for the economy.
The Reserve Bank of India (RBI) is set to meet on October 7, 2026, to decide on interest rates, with markets anticipating a potential increase to 5.50% due to rising inflation and global economic pressures. This meeting comes at a time when the central bank is scrutinizing how effectively commercial banks pass on its policy decisions to the common borrower.
The Gap in Interest Rate Transmission
Between February 2025 and July 2026, the RBI lowered the repo rate by 125 basis points. However, borrowers did not see an equal reduction in their loan costs. Data indicates that while the repo rate fell significantly, the actual rates paid by customers for loans—known as the Weighted Average Lending Rate—dropped by much less. For instance, the marginal cost of funds-based lending rate (MCLR), which dictates interest for many existing loans, saw a relatively small decline of 40 basis points.
This delay, often called sluggish transmission, happens because banks have their own internal calculations for setting rates. While the central bank expects banks to adjust rates immediately when the repo rate changes, lenders often wait to see how the broader economic environment shifts before lowering their lending rates or raising their deposit rates.
Why Public Sector Banks Act Differently
Market data shows a clear difference between how public sector banks (PSBs) and private or foreign banks handle these changes. During the 2025-2026 period, private and foreign lenders were generally faster at adjusting their lending rates. In contrast, PSBs were more conservative, keeping rates higher for longer.
This behavior is largely driven by the need to protect profit margins. Banks make money from the difference between what they earn on loans and what they pay on deposits. With high competition for customer deposits, banks are forced to offer higher interest rates to attract funds. To maintain their margins, they often hesitate to lower the rates they charge on loans.
Furthermore, the structure of bank loans plays a significant role. Private banks often have a larger portion of their loan books linked directly to external benchmarks, which forces them to update rates automatically when the RBI moves. Many PSBs have a higher share of older, fixed-rate, or internally linked loans, giving them more flexibility to delay rate changes.
What This Means for the Economy
When banks do not pass on rate cuts quickly, the RBI’s attempt to stimulate the economy is weakened. If borrowers are still paying high interest rates despite a central bank policy of lower rates, the intended boost to consumer spending and business investment is reduced. Conversely, if the RBI decides to raise rates, the speed at which banks hike their own rates will dictate how quickly borrowing becomes more expensive for households and companies. Investors and analysts continue to track how banks balance the need for deposit growth, credit demand, and the impact of the upcoming RBI policy decision on their future profitability.