Synopsis: The Reserve Bank of India's (RBI) recent 25 basis point reduction in the repo rate to 6.25%—its first cut in nearly five years—is unlikely to significantly boost loan growth due to prevailing tight liquidity conditions. Bankers highlight that without sufficient liquidity and adjustments to the cash reserve ratio (CRR), the benefits of the rate cut may not effectively reach borrowers.
On February 7, 2025, the Reserve Bank of India (RBI) announced a 25 basis point reduction in its key policy rate, bringing the repo rate down to 6.25%.
This move, marking the first rate cut since May 2020, aims to stimulate the economy amid easing inflationary pressures.
Despite this monetary easing, banking industry leaders express concerns that the rate cut alone may not suffice to invigorate loan growth.
The banking system has been grappling with a liquidity deficit since mid-December 2024, which peaked at over three trillion rupees in January 2025.
Pralay Mondal, CEO of CSB Bank, emphasized the importance of liquidity, stating, "A rate cut may not necessarily translate into significant credit offtake unless there is sufficient liquidity in the system."
He anticipates that it will take approximately 3-6 months for the effects to materialize, given ongoing pressures in deposit mobilization.
The absence of a reduction in the cash reserve ratio (CRR)—the portion of deposits banks must hold with the RBI—has also been a point of contention.
Some bankers argue that a CRR cut could have provided immediate liquidity relief, facilitating a more effective transmission of the rate cut to borrowers.
Loan growth in Indian banks has been on a declining trajectory, with December 2024 marking the sixth consecutive month of moderation.
This slowdown is attributed to liquidity constraints, prompting banks to prioritize deposit accumulation over extending credit.
Analysts caution that the rate cut, while a positive step, may be "too little, too late" to rejuvenate credit growth.
They suggest that more substantial easing measures, potentially totaling at least 50 basis points within the fiscal year, coupled with liquidity enhancements, are necessary to achieve the desired economic stimulus.
Currently, approximately 40% of bank loan rates are linked to external benchmarks like the repo rate.
While the pass-through to loan rates is expected to be prompt, there is an anticipated short-term impact on banks' net interest margins due to the lag in deposit repricing.
Macquarie analyst Suresh Ganapathy predicts a potential compression in margins by 10-15 basis points.
Conclusion
The RBI's recent rate cut reflects a strategic move to bolster economic activity.
However, without concurrent measures to alleviate liquidity constraints, such as adjustments to the CRR, the effectiveness of this policy action may be limited.
A comprehensive approach addressing both interest rates and liquidity is essential to stimulate loan growth and achieve broader economic objectives.
Disclaimer: The information provided in this article is based on current data and expert opinions as of February 8, 2025. Economic conditions are subject to rapid change, and readers are advised to consult financial advisors or conduct further research before making financial decisions.
