Banks wait for the bulk of outstanding deposits to mature and renew them at reduced rates before transmitting the rate reduction to lending rates on past loans.
Even as the government cut interest rates, the benefits hardly reach the end-customer due to rigidity in banks’ deposit interest rates. In the March bulletin, RBI has explained why even when the Monetary Policy Committee cuts the policy rates, the market take it too long to take benefits from the action. RBI has said that the transmission to the bank deposit and lending rates has been delayed and partial for a variety of reasons. “Banks wait for the bulk of outstanding deposits to mature and renew them at reduced rates before transmitting the rate reduction to lending rates on past loans,” RBI said in its March bulletin. The report also added that the banks hold long-term deposits at fixed interest rates, which do not move in-line with the change in the policy rate.
The central bank also explained that even when banks reduce deposit interest rates in-line with the policy rate, only the fresh deposits face the impact of such reduction immediately, thus customers with existing loans do not get the benefit soon. This is why the transmission to lending rates on outstanding loans lags transmission to outstanding term deposit rates during the easing cycle.
However, due to slow transmission, it becomes difficult for the government to revive the demand in the market. “The success of monetary policy critically hinges on the effective transmission to the entire spectrum of interest rates in the system,” RBI said in its report.
The speed and magnitude of monetary transmission vary across various financial market segments such as money, bond and credit markets. An analysis of monetary transmission in the Indian context in the recent period suggests that monetary transmission was full and reasonably swift across various money market segments and the private corporate bond market, RBI said.