“During the tightening cycle, the pace of increase in deposit rates (term deposits and savings account deposits taken together) has lagged the pace of increase in lending rates so far,” wrote RBI economists Yuvraj Kashyap, Avnish Kumar, Anand Prakash and Shubhangi Latey in the central bank’s November Bulletin. The views do not represent those of the RBI.
The authors pointed out that while the increase in term deposit rates in the latest tightening cycle has outstripped that in lending rates, savings deposit rates of banks – which represent a third of total deposits – stayed almost unchanged. As a result, the increase in banks’ overall cost of funds saw moderation. Savings deposits are a source of low-cost funds for banks.
“Accordingly, higher NIMs (net interest margins) have been observed during the current tightening phase so far,” the authors wrote. Most banks have reported strong profits over the last year-and-a-half, primarily due to the boost to margins received by the higher policy rates. Large surplus liquidity conditions which persisted till around June 2022 had reduced cost of funds for banks. The RBI had infused large amounts of liquidity into the banking system during the Covid crisis in order to bring down cost of funds and protect the economy amid the pandemic.
The central bank has increased the repo rate by a total of 250 basis points from May 2022 to February 2023 to bring down high inflation.
The authors said the external benchmark lending rate (EBLR) – which banks shifted to in 2019 – had hastened adjustments in deposit rates during the easing cycle undertaken by RBI in 2020-22. At the time, banks were incentivised to lower term as well as savings deposit rates to shield NIMs in an environment of falling interest rates.
Under the EBLR system, bank lending rates are raised or lowered almost as soon as the policy rate is changed by the RBI. The external benchmarks used are rates such as the policy repo rate itself.According to authors, an empirical bank-level analysis showed that surplus liquidity in the banking system and a higher share of current account saving account deposits in total deposits has a negative and significant impact on lending rates.
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