Key Points

However, it takes 12 to 24 months for the full effects of rate changes to materialise in banking performance as transmission is neither immediate nor uniform, showed a Boston Consulting Group (BCG) study.

"Such policy rates are often increased to cool down an overheated economy, to rein in inflation," said Deep Narayan Mukherjee, Partner and Director, BCG.

"While rates act as enablers, the actual expansion of credit hinges on borrower sentiment and lenders’ risk appetite," Mukherjee added.

According to the study, the repo rate is the most accurate predictor across all metrics, even though rate changes affect all Scheduled Commercial Banks (SCBs).

A 50 bps increase in the repo rate leads to a 1.11 per cent rise in Net Interest Income (NII) across SCBs, with PSBs showing a sharper 1.45 per cent gain, it noted.

Compared to private banks, public sector banks (PSBs) were more responsive to repo rate changes. PSB advances increased by 1.4 per cent in response to a 50 basis point hike, while private sector players — especially larger ones — reacted more subtly.

Lower interest rates don't always translate into more lending, despite what many people think. Rates serve as facilitators, but borrower sentiment and lenders' risk tolerance ultimately determine whether credit is expanded, the study said.

For example, despite rising interest rates, there was strong credit growth from 2022 to 2023.

Similarly, it was discovered that advances across SCBs increased by 1.16 per cent with a 50 basis point increase in the repo rate and decreased by 1.25 per cent with a similar cut.

“The era of one-way, predictable interest rate cycles is likely over. With geopolitical disruptions and domestic market shifts reshaping the landscape, Indian banks can no longer afford to rely on conventional planning models. Banks need to more explicitly embed Interest rate sensitivity in business projections than has been the case for at least some of them till now,” the report mentioned.

- IANS