Indian banks face deposit dilemma as RBI rate cuts squeeze margins

Indian banks are struggling to balance deposit mobilisation and margin protection after the RBI's latest rate cut, as savers shift away from banks even as credit growth remains strong

Indian banks find themselves in a delicate position following the Reserve Bank of India’s (RBI) 25-basis point rate cut. While they need to lower deposit rates to protect net interest margins (NIMs), they also have to mobilise deposits to fund credit growth, which is picking up in the economy and is expected to remain robust heading into the fourth quarter starting January 2026. This leaves banks with limited room to cut deposit rates at a time when lower returns are already pushing savers away from the banking system towards equity markets.

 

The RBI cut the repo rate by 25 basis points to 5.25 per cent in early December, taking the total reduction in the current easing cycle to 125 basis points. According to RBI data, in response to the cumulative 100-bp cut in the policy repo rate, the weighted average lending rate (WALR) of banks has declined by 69 bps for fresh rupee loans during February-October 2025 (the interest rate effect is 78 bps). One basis point is a hundredth of a percentage point.

 

Additionally, the moderation in the WALR of outstanding rupee loans has been to the extent of 63 bps. Meanwhile, on the deposit side, the weighted average domestic term deposit rate (WADTDR) on fresh deposits has declined by 105 bps, while that on outstanding deposits has softened by 32 bps over the same period.

 

Since a large portion of banks’ loan portfolios is linked to external benchmarks that automatically reset when the repo rate is reduced, lending rates decline immediately. However, deposit rates take longer to adjust, causing banks’ NIMs to feel the squeeze during this transition period.

 

According to data, NIMs of private sector banks in Q2FY26 stood at 3.87 per cent compared to 4.02 per cent at the end of Q4FY25 – a drop of 15 bps. In the same period, NIMs of state-owned banks dropped 10 bps to 2.71 per cent in Q2FY26 from 2.81 per cent in Q4FY25. The drop in NIMs was sharper in Q1FY26, and in Q2 the banking sector delivered better-than-expected NIMs, even after absorbing the full impact of the 50-bp repo cut, supported by meaningful reductions in saving account rates.

 

Experts said the impact of the additional rate cut will be felt in the final quarter of the current financial year. However, liquidity infusion by the central bank and the cut in the cash reserve ratio (CRR) are expected to partially cushion the impact on banks, unless the central bank goes for another rate cut in the next meeting of its Monetary Policy Committee (MPC) scheduled for February 4-6, 2026.

 

“We had indicated there would be a dip in the net interest margin (NIM) in the third quarter, after which we expected improvement, assuming there were no further rate cuts. With the recent rate cut, it will take a little longer for us to absorb the impact because the reduction will be passed on to borrowers. And this will be the case not just for us but the banking industry in general,” said Amitabh Chaudhry, managing director and chief executive officer of Axis Bank said in a recent interview with Business Standard.

 

CS Setty, chairman, State Bank of India (SBI), earlier this month, told Business Standard, that cutting rates on fixed deposit would be difficult. “We must realize that despite that 100 bps repo rate cut, the fixed deposits have not been cut 100 bps. Many of us are trying to increase the CASA. We have not reached 45-46 per cent CASA what we have had in COVID time. So system level, we should be looking at 38-39% CASA. It's a good CASA to have,”he said.

 

Banks' ability to cut deposit rates will also depend on liquidity, Chaudhry said. "Once liquidity comes back and stabilises and the rupee becomes relatively stable, we should see deposit rates beginning to stabilise”.

 

“We are hopeful that over the next one to two quarters, some of these rates will settle. The only way to ensure that NIMs remain at current levels — given that the benefit of rate cuts has already been passed on the yield side — is for deposit rates to come down. Current and savings accounts are gradually trending in a downward direction. This creates inherent pressure on the overall cost of funds. Therefore, overall deposit rates need to come down gradually for NIMs to move back to the levels that all of us are aiming for”, he said.

 

As depositors become more savvy and increasingly invest in instruments such as mutual funds and pension products, funds are returning to the banking system largely in the form of wholesale deposits. These deposits often carry higher run-off rates or come at a higher cost than retail deposits. As a result, the nature of deposits is changing, with customers holding less money in current and savings accounts. Consequently, the share of CASA in overall deposits is declining, a trend that is visible across the banking sector rather than just a single bank.