Boomerang effect: Cut in repo rate may not bring down interest rates any time soon

For a bank to make a profit, there should be a significant difference between its lending and deposit rate.

RBI has cut down repo rates five times in a row since February 2019 but there is hardly any visible change in the lending rates of the banks. Instead, a few loans have become more expensive. Despite the government’s attempts to increase the investments by bringing down the lending rates in the short-term, it is likely for it to take a year or so for the difference to appear at the consumer-end. The reason for this slow transition is however not unjustifiable. Repo rates have a very limited impact on a bank’s overall cost of funds, and reducing lending rates just because the repo has been cut is not feasible for banks.

For a bank to make a profit, there should be a significant difference between its lending and deposit rate. Thus to reduce the lending rate and to be profitable at the same time, the banks will have to cut down their deposit rates. However, even a slight reduction in the deposit rate could make the depositors shift in a rival bank where they get better returns on their savings. 

Another reason why the banks cannot immediately cut the deposit rates is that most of the deposits are in the form of term deposits. “65 per cent of total deposits are term deposits and take, on average, up to two years to get repriced at fresh rates. Therefore, banks generally go slow on reducing the interest rates on advances as deposits take longer to get repriced,” Miren Lodha, Director, CRISIL Research, said The Indian Express.

Meanwhile, on the contrary, the existing loan rates for a few loans have increased, which is seen as a way the banks are trying to manage their finances. Suvodeep Rakshit of Kotak Institutional Equities explained it to The Indian Express that if the banks are under pressure to reduce the interest rate they charge on new loans, then one of the things they could do is to push up the interest rates on old loans that allow for such flexibility.