It felt like a breath of fresh air for anyone with a loan or thinking of getting one. When the Reserve Bank of India (RBI) reduced the repo rate, the common expectation was simple: lower interest rates from banks. Cheaper home loans, more affordable car loans, and lower EMIs. Yet, in a surprising turn of events, the opposite happened. Even after the Repo Rate was reduced by the RBI in July, many found that Banks Increased Their Interest Rates.
This situation has left many people scratching their heads. If the central bank makes it cheaper for banks to borrow, why aren't they passing on the benefits to us, the customers? It seems counterintuitive, but there are several complex factors at play behind the scenes. Let's break down what actually happened and why your loan rates went up when they were supposed to go down.
What Actually Happened?
On June 6, 2025, the RBI announced a significant 50 basis-point (bps) cut in the repo rate, bringing it down to 5.50%. For context, a 50 bps cut is 0.50%. This was a clear signal from the RBI to encourage economic activity by making borrowing cheaper. When the Repo Rate is Reduced by RBI, banks are expected to follow suit and lower their lending rates.
However, the data from July told a very different story. Instead of going down, the weighted average lending rate (WALR) on new loans actually rose from 8.62% in June to 8.80% in July. So, despite the fact that the RBI Reduced Repo Rate in July, borrowing from banks became more expensive. This baffling outcome wasn't a mistake; it was the result of a combination of market forces and banking strategies.
Why Did Bank Lending Rates Rise?
So, what caused this disconnect? Why did banks decide to hike rates when the central bank was pushing for a reduction? Here are the four key reasons behind this unexpected move.
1. Shift in Loan Composition (MSMEs)
One of the biggest reasons for the average lending rate going up was a change in who the banks were lending to. In July, banks reported that a larger portion of their loans went to Micro, Small, and Medium Enterprises (MSMEs). MSME loans are generally considered to have a slightly higher risk profile compared to, say, a home loan to a salaried individual. To compensate for this risk, banks charge a higher interest rate on these loans.
So, even if the interest rates for home loans or personal loans remained the same or dropped slightly, the overall average lending rate was pulled up because of the increased volume of these high-yielding MSME loans. It’s like a fruit seller’s average price going up not because he increased the price of apples, but because he sold more expensive mangoes that day.
2. Bond Markets & Rising Yields
This might sound a bit technical, but it’s crucial. While the RBI controls the short-term repo rate, banks often look at long-term government bond yields to price their own long-term loans (like home loans). A bond yield is essentially the return an investor gets from a government bond.
In July, even though the Repo Rate was Reduced, long-term bond yields started to climb. This was driven by several factors, including worries about future inflation and changes in the RBI's liquidity operations. When these long-term yields go up, it signals that the cost of borrowing money for a longer period is increasing. For banks, this rising cost of funds made them reluctant to cut interest rates for customers. They were essentially caught between the RBI's short-term signal and the market's long-term outlook.
3. Transmission Gap
"Transmission" is the process through which the RBI's policy rate changes are passed on to consumers by banks. This process, however, isn't always smooth or uniform. In this case, there was a noticeable gap between different types of banks.
Reports showed that public sector banks (government-owned banks) were quicker to respond to the RBI's rate cut. They reduced both their lending and deposit rates more aggressively than their private sector counterparts. Many private banks, on the other hand, held back. This uneven transmission meant that while some customers saw benefits, many others didn't, which kept the overall average lending rate high.
4. Liquidity Pressures & Funding Costs
"Liquidity" simply refers to the amount of ready cash available in the banking system. Recently, the system faced a bit of a cash crunch. This meant that the cost for banks to borrow money from each other for very short periods (overnight) went up. In fact, these overnight borrowing rates shot up about 40 bps higher than the RBI's new 5.50% repo rate.
When a bank's own cost of acquiring funds increases, it becomes very difficult for them to offer cheaper loans. They become more cautious and are more likely to pass on these higher internal funding costs to borrowers. This liquidity tightness was a major reason why Banks Increased Their Interest Rates, as they needed to protect their own profit margins.
At a Glance
Here’s a quick summary of the factors that pushed lending rates up:
| Factor | Impact on Lending Rates |
|---|---|
| High-yield MSME loans | Increased the overall average lending rate despite the repo rate cut. |
| Rising bond yields | Signalled a higher cost of funds for banks, making them hesitant to cut rates. |
| Slower private bank transmission | Public banks cut rates faster, but the lag from private banks kept the average high. |
| Tight liquidity & funding stress | Higher internal borrowing costs for banks were passed on to loan customers. |
Bottom Line
So, while the headline news that the Repo Rate is reduced by RBI brought cheer, the reality on the ground was far more complicated. The final interest rate you pay is not just a reflection of the RBI's repo rate but a product of various interconnected economic factors.
The decision by banks to increase their interest rates in July was driven by a perfect storm of:
- A change in their loan portfolio towards higher-yielding MSME loans.
- Rising long-term bond yields that increased their funding costs.
- A sluggish and uneven passing on of the rate cut, especially by private banks.
- A cash crunch in the banking system made day-to-day operations more expensive.
For consumers, this serves as a reminder that the central bank's actions are just one piece of the puzzle. Market dynamics, bank strategy, and liquidity conditions all play a powerful role in determining the final interest rate on your loan.
