One may wonder; when repo rates are down, what is the problem for banks to cut rates? It is in the way rate cuts are passed on to borrowers. In floating rate loans, any change in the base rate is to be effective with immediate effect. So, whether repo rates are going up or they are going down; impact on loans will be immediate. However, long term deposit rates are fixed and can change only for fresh deposits or when renewed. This is what creates a dichotomy where lending rates have fallen; not the deposit rates.

Net interest margins (NIM) is one of the key metrics for measuring profitability. It is the spread between average loan rates and average cost of funds. In the current scenario of falling repo rates, the deposit rates are not falling in sync, and that is depressing the NIMs. The banks really do not have a choice but to wait till the deposits come for renewal or focus more on fresh deposits. In both these cases, the banks are already in a pitched battle with mutual fund to be able to attract liquid funds. With MFs in a clear advantage on returns over bank FDs, banks are struggling to hold NIMs. 

For all those who are worried about the banks losing on NIMs, there is a little background to look into. Between 2022 and 2024, when the interest rates were going up one-way, the banks made hay. The lending rates were going up in sync with the repo rates but the deposit rates would move up only with a lag. It was the period when most banks managed to expand their net interest margins or NIMs to record levels. However, during that period, there were very few banks that really came forward to share their higher profits with the borrowers in the form of lower borrowing rates. That is why the NIM story is striking now. Why should borrowers be made to pay more? 

Most banks realize that it would be very naïve to ask borrowers to pay more to boost their profits. Borrowers will only be driven by the base cost of funds and the prevailing rates of interest. When the rates were going up, the demand for credit far outstripped the growth in the deposits. Hence, at that point, it was a simple mathematical calculation to push up rates and continue to lend. Today, the growth in loans is not outstripping the deposit growth by the same margin. Hence to expect that the banks can still lend at higher rates would be optimistic. It is also time for the RBI to intervene and ensure that banking freedom is also circumscribed by customer fairness!