That the RBI’s monetary policy announced on June 6 aims at giving economic growth a shot in the arm has received accolades from many market participants. However, the policy measures have some downsides.

Ensuring high growth rate is necessary, but does it ensure ‘distributive justice’? No. Consequent upon the 50 basis point (bps) reduction in the repo rate, banks will reduce their lending as well as deposit rates. However, these reductions are asymmetric.

For example, during February 2019 to March 2022 (easing cycle), when the repo rate was reduced by 250 bps, the weighted average domestic term deposit rate on fresh deposits and outstanding deposits reduced by 259 bps and 188 bps, respectively, whereas the weighted average lending rate on fresh rupee loans and outstanding rupee loans fell by 232 bps and 150 bps, respectively.

Depositors’ woes

Banks reduce their deposit rates faster and by larger margins than the lending rates in order to protect their Net Interest Margins (NIMs). Thus, the depositors, especially the middle-class constituting majorly senior citizens and salaried workers, who are generally risk-averse, will be adversely affected in terms of lower interest income.

They will either reduce their consumption or move their savings to riskier destinations which offer higher return such as co-operative banks and non-banks. Therefore, the income tax exemption given by the Budget will be partly taken away by banks through the backdoor. There is thus a strong need for increasing the additional interest rate that seniors get over and above what the general public get.

Remittances in the form of Non-Resident Indians’ deposits, particularly from the US, have already become sluggish due to the latter’s new policies. And this will worsen as the interest rate differential between the US and India contracts.

The effect of lower lending rates on credit offtake is not as straight as assumed. It depends on several factors — such as pace and extent of monetary transmission to lending rates, composition of banks’ loan portfolios, elasticity of loan demand by industries, rates offered by alternative sources of funds, particularly in the overseas markets, and domestic and global macroeconomic conditions. While the domestic economy is performing well, the global economy is not.

As for the ‘personal’ segment, a leader in credit offtake, education loans are destined to decline further; and auto loans may suffer from supply constraints emanating from China’s restrictions on export of magnets.

Home loan demand, especially from middle-class households, will hinge on reduction in their interest income and how the consumer inflation plays out.

The optimism regarding the likely performance of the agriculture sector is somewhat premature. Experience reveals that the temporal and spatial distribution of a ‘normal’ monsoon has, more often than not, been ‘abnormal’.

The time is not ripe to predict how banks will be affected. However, they would try to rebalance their deposit and lending rates such that their NIM and, consequently, profits are protected. However, they have to be watchful about possible deterioration in their asset quality, as bad debts are sown in good times. Besides, there could be diversion of loans by the ‘smart’ borrowers, especially when the stock market is buoyant.

These would require banks to bolster their risk management systems and internal controls, and the central bank to have stricter and prompt supervision.

If banks experience substantial erosion of their deposit bases, they have to look for alternative sources of funds including bonds, which, however, would mean weakening of their classical ‘financial intermediation’ function.

Das is a former Assistant General Manager (Economist), SBI. Views are personal

Published on June 17, 2025