India’s banking system is witnessing a slowdown in the transmission of policy rate cuts to both lending and deposit rates as credit growth continues to outpace deposit mobilisation, creating funding pressures that are hardening deposit rates despite lower benchmark rates, according to an analysis by HDFC Bank.
The report said transmission to fresh deposit rates, measured by the weighted average term deposit rate, stood at minus 55 basis points by March-end compared with minus 95 basis points in December, while transmission to fresh rupee loan rates slowed to minus 93 basis points from minus 105 basis points over the same period.
This moderation has come even as the repo rate declined by 125 basis points between January 2025 and March 2026, highlighting growing frictions in the monetary transmission mechanism. Data showed outstanding rupee lending rates for scheduled commercial banks fell by 88 basis points over this period, while outstanding term deposit rates declined by only 47 basis points.
HDFC Bank attributed the slowdown partly to a widening mismatch between system credit and deposit growth. As of April 30, credit growth remained strong at 16 per cent year-on-year, while deposit growth lagged at 12.3 per cent, keeping the credit-deposit ratio elevated at 82.0.
The bank said credit momentum strengthened notably in the second half of FY26, supported by underlying demand following GST rate cuts and a sharp rise in incremental credit. At the same time, corporates shifted their financing preference towards bank loans as yields on corporate bonds and commercial paper rose.
This shift is visible in the flow of resources to the commercial sector. The share of non-food bank credit in total funding rose to 65.4 per cent in March 2026 from 55 per cent in November 2025, while reliance on non-bank sources such as corporate bonds, commercial paper and NBFC credit declined sharply. Commercial paper issuances fell from 3.4 per cent of total flows in November to 0.2 per cent in March.
Market rates reinforced this migration to banks. Three-month commercial paper rates, after moderating in mid-April, rose again to above 7 per cent, while AAA corporate bond yields remained elevated around 7.7 per cent.
On the liability side, banks faced rising funding costs as certificate of deposit issuance surged to Rs 5.3 lakh crore in the fourth quarter, the highest in eight quarters. CD rates, which had eased briefly, began rising again, adding pressure on deposit pricing.
Liquidity conditions also tightened in the second half of FY26. Average system liquidity surplus dropped to Rs 1.36 lakh crore from Rs 2.2 lakh crore in the first half, due to factors such as foreign exchange interventions, higher currency in circulation and seasonal pressures.
HDFC Bank said these conditions forced banks to raise deposit rates in March, slowing the pace at which earlier policy rate cuts could be transmitted to depositors and borrowers.
Sectoral patterns in lending also influenced transmission. Near-complete transmission was observed in education, MSMEs, rupee export credit and other personal loans, while agriculture, professional services and trade saw slower pass-through. Transmission to infrastructure and large industries moderated sharply after lending rates spiked in March.
The structure of loan pricing further shaped outcomes. Around 65 per cent of outstanding loans are linked to external benchmark lending rates, which show faster transmission compared with MCLR-linked loans where pass-through remains below 50 per cent. Among private banks, nearly 90 per cent of loans are EBLR-linked, supporting relatively quicker adjustment.
Credit growth remained broad-based. Retail loans expanded strongly, led by housing, vehicle and gold loans. Services credit rose sharply, particularly to NBFCs and trade, while industry credit accelerated across firm sizes, partly due to reduced bond and equity issuances. Incremental non-food bank credit rose to Rs 30,837 billion in FY26 from Rs 17,984 billion in FY25, with a pronounced pickup in the second half.
Looking ahead, HDFC Bank expects credit momentum to remain strong. Corporates may continue preferring bank loans as market yields stay elevated, while higher energy costs and inflation could increase working capital requirements. Household borrowing may also rise if the cost of living increases, while credit guarantee schemes could support MSME lending.
The report drew parallels with the 2022 period during the Russia-Ukraine war, when rising energy costs and inflation drove credit growth sharply higher. A similar dynamic, it said, could emerge if inflationary pressures persist in the current cycle. |
