The article, published in RBI’s November bulletin, notes that lending rates came down quickly during the pandemic because of large surplus liquidity and subdued credit demand, facilitating the transmission of RBI’s rate cuts.Conversely, the normalisation of surplus liquidity and robust credit demand ensured that lenders passed on to borrowers RBI’s rate hikes that started in May 2022.
The study incorporates an empirical bank-level analysis indicating that a higher share of current and savings account deposits has a softening impact on lending rates. In contrast, a higher capital adequacy ratio has a positive and significant impact. A high credit deposit ratio also increases the pass-through to deposit and lending rates. At the same time, an excess holding of government bonds lowers the increase in interest rates passed on to deposits.
According to the report, the tightening cycle that began in May 2022 resulted in a higher magnitude in the policy repo rate than the earlier cycle. Although lending rate hikes have already outpaced deposit rate increases, banks are not yet done with revising interest rates on loans. This is because repo rate hikes are working their way through the system, and transmission has slowed down because many banks have reduced the spread between the lending rate and the repo rate to increase their market share.