A recent Reserve Bank of India study highlights that banks are slower to reduce interest rates for borrowers than they are to raise them. Banks passed on only 64% of recent repo rate cuts, compared to passing on 76.4% of rate hikes. This strategy helps banks keep their profit margins on loans stable, though it keeps borrowing costs for businesses higher than the central bank's policy intentions.
A new research study by the Reserve Bank of India (RBI) has shed light on how banks manage their interest rates. The data shows that banks adjust loan interest rates much faster when the RBI raises rates than when it lowers them. During the recent period of falling interest rates, banks passed on only 64% of the rate cuts to borrowers. In contrast, when the RBI was raising rates, banks were quick to pass on 76.4% of the increase to customers.
This behavior is a key factor in how banks maintain their profit margins on loans. When banks keep lending rates high while their own cost of borrowing from the RBI goes down, the difference between the two—often called the net interest margin—widens. This allows lenders to protect their profitability even during times when the central bank is trying to make credit cheaper for the economy.
For investors, this study explains why bank earnings can remain resilient even when the interest rate cycle turns. By shifting their mix of loans and focusing on products where they have more pricing power, banks can ensure that the average cost of credit for the broader economy does not drop immediately alongside the central bank's policy rate.
The study also revealed a clear difference in how banks treat different types of borrowers. Small and medium enterprises (MSME) saw more benefit, with their loan rates falling by 122 basis points. However, large industrial loans saw much smaller relief, with rates dropping by only 67 basis points. This suggests that banks find it easier to keep loan rates sticky and high for large corporate borrowers compared to smaller businesses.
While this strategy is positive for bank profits in the short term, it creates a potential risk for the future. If the cost of borrowing remains too high for too long, it may discourage businesses from taking new loans. A slowdown in loan demand or a difficulty for large companies to repay expensive debt could eventually hurt the bank's asset quality. Investors monitoring banking stocks may want to watch for signs of loan growth and how the banks manage their portfolio mix as interest rates continue to change.