Low rates do not push credit growth: BCG
The study, Interest Rate Sensitivity in Indian Banking, highlights that the impact of policy rate changes on bank performance is neither immediate nor uniform, and that credit growth is more dependent on borrower sentiment and lender confidence than on rates alone.
Empirical evidence underscores this point: credit growth remained weak during 2014–2016 and 2018–2020 despite declining or stable rates, while lending surged in 2022–2023 amid rising rates.
The only clear instance where falling rates aligned with credit growth was during 2016–2018. BCG finds that unless credit demand is robust, rate cuts—unless sustained for 18–24 months—rarely drive significant lending increases.
The Reserve Bank of India (RBI) raised the repo rate by 250 basis points between 2022 and 2023 to tackle inflation, only to cut it by 100 basis points in early 2025 to boost growth. This policy reversal reflects mounting external risks—geopolitical tensions and structural imbalances in the global financial system—that now weigh more heavily on India's interest rate path than domestic growth-inflation trade-offs.
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BCG's report urges banks to abandon linear forecasting and adopt scenario-based planning. It shows that repo rate changes take 12–24 months to influence key metrics such as credit, deposits, and Net Interest Income (NII), with public sector banks (PSBs) proving more responsive than private ones. A 50 basis point repo hike, for example, led to a 1.4% increase in advances for PSBs, compared to 1.16% overall.
Interestingly, deposit mobilisation showed little correlation with interest rates.
PSBs, in particular, were largely unaffected, thanks to their stable depositor base. Even private banks responded weakly. Factors such as customer engagement, competition, and liquidity management mattered more than monetary policy.
By contrast, NII was highly rate-sensitive. A 50 basis point increase in the repo rate boosted NII by 1.11% across all scheduled commercial banks, and by 1.45% for PSBs. Rate cuts, predictably, led to income declines.
To navigate this shifting landscape, BCG recommends overhauling internal pricing frameworks, which still rely too heavily on historical cost of funds. This misaligns profitability and misallocates capital. A move toward marginal cost-based pricing and improved balance sheet simulations is essential. Meanwhile, changing saver preferences—toward mutual funds, pensions, and direct investments—mean banks must use data science to better understand and serve depositors, the report said.
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