Broad-based transmission of policy rates still some way off, say experts

RBI has moved liquidity into the surplus side from a deficit four months ago, and some experts feel it may be preparing for monetary transmission before it cuts the repo rate again next week

A broad-based transmission of the 25 basis point rate cut enacted in February will likely take some more time to be transmitted down the line, despite the banking system's liquidity moving into the surplus side after nearly four months of deficit following increased government spending and the central bank's ongoing efforts to inject liquidity through dollar-rupee buy/sell swap auctions, open market operations (OMOs), and variable rate repo auctions.

 

The delay in transmission, though, is largely because of deposit tightness in the system stemming from structural issues in the banking system, which has led banks to increasingly rely on bulk deposits and certificates of deposit (CDs) to meet the economy's credit demands.

 

The Reserve Bank of India (RBI) monetary policy committee (MPC) cut rates by 25 bps in February – the first such cut in almost five years. However, the lower policy rate has not trickled down entirely. While existing loans marked to external benchmarks have seen transmission, fresh loans are yet to reflect the rate cut.

 

This is evident from the fact that the weighted average lending rate (WALR) on fresh rupee loans of scheduled commercial banks (SCBs) stood at 9.40 per cent in February 2025 as compared 9.32 per cent in the previous month while WALR on outstanding rupee loans of SCBs declined to 9.80 per cent in February from 9.87 per cent in January. Meanwhile, the one-year median Marginal Cost of Funds-based Lending Rate (MCLR) of SCBs declined to 9 per cent in March 2025 from 9.05 per cent in the previous month. And, the weighted average domestic term deposit rate (WADTDR) on fresh rupee term deposits of SCBs stood at 6.48 per cent in February as compared to 6.56 per cent in January.

 

Experts had earlier blamed liquidity as the main issue for transmission, but the RBI has since then pulled the system out of a deficit by injecting over Rs 8 trillion into the system over the past three months. The net liquidity was in a surplus of Rs 1.93 trillion on Wednesday, according to the latest RBI data.

 

“The transmission of lending and deposit rates may not be easy due to structural issues in the banking system, particularly like the shifts in the deposit profile. Household savings are moving away from deposits towards assets like equities, insurance, and pension funds, leading to a change in the banking system’s deposit composition from CASA (current and savings accounts) and retail term deposits to bulk deposits. This makes it difficult for banks to reduce deposit rates, a key factor in considering cuts to MCLR,” said Kanika Pasricha, chief economic advisor, Union Bank of India.

 

“While larger banks with a significant market share of deposits may consider reducing rates, the distribution of liquidity in the system is uneven, with a few banks holding a disproportionate share and hence may impede broad broad-based transmission. This results in Rs 2-3 trillion being parked in the standing deposit facility (SDF). The unequal distribution of liquidity extends to deposits, with a few private and large public sector banks commanding most of the market share,” she said.

 

Pasricha added that the RBI may need to consider providing additional liquidity measures like a liquidity assurance of a certain percentage of NDTL (Net Demand and Time liabilities), create an on-tap term money market facility to address the liquidity imbalance and correct the market anomaly. Without such measures, the wide gap between the banks in terms of liquidity will continue to affect funding rates, she said.

 

Having said that, some banks, including HDFC Bank, YES Bank, Bandhan Bank, and State Bank of India (SBI) have either discontinued the special fixed deposit schemes they had launched to garner more deposits by offering better interest rates. Effective April 1, SBI has withdrawn a special fixed deposit scheme – Amrit Kalash – which offered 7.10 per cent interest rate for 400 days. SBI started this special deposit scheme in April 2023. While HDFC Bank – the country’s largest private sector lender – reduced deposit rates by 35 basis points on fixed deposits with a tenure of 2 years and 11 months (35 months) and by 40 basis points on fixed deposits with a tenure of 4 years and 7 months (55 months), Yes Bank lowered FD rates on select tenures by 25 bps.

 

“The transmission of policy rate cuts will depend on banks' ability to lower deposit rates, which in turn is influenced by their credit pipeline. The 25 bps cut in February did not see full transmission. While existing loans linked to EBLR were repriced, fresh loans did not fully reflect the rate cut. For MCLR, which is linked to deposits, transmission is challenging as long as banks do not reduce deposit rates”, said Madan Sabnavis, Chief Economist, Bank of Baroda.

 

“To manage liquidity and meet credit demand, banks have raised bulk deposits and certificates of deposits (CDs) heading into March. Additionally, since the small savings rate has remained unchanged, banks may be hesitant to cut deposit rates. In a market that is underperforming, reducing deposit rates could lead to depositors moving their funds to the mutual fund industry. Therefore, while some banks may choose to reduce deposit rates on specific tenures, a broad-based transmission of policy rate cuts to both deposit and lending rates is still some distance away”, he added.

 

Even as the transmission of the February rate cut has not percolated down, the consensus is that RBI’s MPC will cut rates by another 25 bps in their bi-monthly monetary policy meeting next week. A softening retail inflation rate, which eased to a seven-month low of 3.61 per cent in February, down from 4.31 per cent in January, as food prices softened, has bolstered hopes for a second consecutive interest-rate reduction.

 

The RBI also seems to be taking proactive steps to speed up monetary transmission of policy rates to the lending and deposit rates by easing financial conditions. Earlier this week, the central bank surprised the market by announcing a Rs 80,000 crore open market operation (OMO) to infuse liquidity into the banking system by purchasing bonds in April. Experts say the central bank could be preparing the ground for monetary transmission before cutting the policy repo rate.