Episode 2 : The Repo Rate Squeeze – Different Year, Same Trap

Policy Vs Practice Series

THE BEGINNING

In just 67 days of early 2020, the RBI slashed the repo rate by 115 basis points — the steepest short-term cut since the global financial crisis.

Corporate loan yields at India’s top banks fell by nearly 1% in a single quarter.

Deposit costs? They barely moved — down just 0.25%.Billions in liquidity flooded the system… and still, margins thinned.

Fast forward to 2025. A fresh 100 bps cut earlier this year — followed by an August pause at 5.50% — is setting up the same squeeze.

Different year, same playbook. And the same margin trap is waiting.

THE STRATEGY (Repo Rate)

Think of a bank like a shop. It “buys” money from depositors and “sells” money to borrowers.

When the RBI cuts rates, the price at which the shop can sell (loan rates) drops almost overnight. But the price it pays to buy (deposit rates) takes longer to come down — because those deposits are often “locked in” for months.

For a while, the shopkeeper is selling cheaper……but still paying the old, higher price for stock. Profits shrink — not because there aren’t enough customers, but because the cost structure hasn’t caught up with the new market reality.

So what does the smart shopkeeper do?

• Clear old stock quickly to make room for goods bought at the new, lower cost.

• Push high-margin items to balance the loss from price cuts.

• Attract more footfall so that even with lower margins, volume keeps the business afloat.

  
  

Banks facing this squeeze in 2025 follow a similar playbook:

• Clear Old Stock → Reprice or Run Off High-Cost Deposits

  • As fixed deposit maturities come up, banks renew them at lower rates or shift customers to savings products.

  • The faster this happens, the quicker funding costs align with the lower loan rates.

    
    

• Push High-Margin Items → Focus on Retail & SME Lending

  • Home loans, gold loans, personal loans, and SME working capital often have better spreads than large corporate loans.

  • By leaning into these, banks can protect margins even when corporate yields are wafer-thin.

    
    

• Attract More Footfall → Drive Loan Volumes

  • Even if each loan earns less per rupee, a surge in volume can partly offset the loss in yield.

  • This often means ramping up marketing, simplifying products, and speeding up approvals to grab market share quickly.

  
  
  
  

  

  Repo Rate Squeeze

  But here’s the catch…

  
  

  When you’re sitting on surplus liquidity……and you need to put that money to work……the big corporate borrowers know it.

  
  

  They walk in with term sheets that are already razor-thin. They ask for just a little more shaved off the rate. And they get it — because idle money earns nothing.

  
  

  Meanwhile, the bank’s cost of funds hasn’t fully adjusted. Every basis point cut on the lending side bites a little deeper.

  
  

  It’s a race to deploy funds before the margin vanishes……and sometimes, the race is over before it even begins.

  
  

  📊 Proof

  The numbers don’t lie.

  2020:

  • RBI repo rate cut: 115 bps in 67 days.

  • Corporate loan yields: ↓ 80–100 bps in one quarter.

  • Deposit costs: ↓ just 25–30 bps in the same period.

  • Net interest margins (NIM) for top banks: compressed by up to 40 bps.

  
  

  2025:

  • RBI repo rate cut: 100 bps between February and June.

  • August 2025: Pause at 5.50%.

  • Early post-cut data shows corporate yields already down ~60–70 bps.

  • Deposit repricing? Lagging at ~20 bps reduction so far.

  
  

  Across the banking spectrum, the same squeeze is visible:

  • HDFC Bank: Corporate lending yields ↓ 65 bps in Q1 FY26; deposit costs ↓ 22 bps.

  • State Bank of India: Yields ↓ 60 bps; deposit costs ↓ 18 bps.

  • ICICI Bank: Yields ↓ 68 bps; deposit costs ↓ 25 bps.

  • Axis Bank: Yields ↓ 62 bps; deposit costs ↓ 20 bps.

  • Kotak Mahindra Bank: Yields ↓ 70 bps; deposit costs ↓ 19 bps.

Key Takeaways:

• PSUs are leading transmission, with sharper rate cuts than private banks.

• SBI, as a barometer, confirms deeper margin compression (NIM at 3.02%) despite improving liquidity.

• Private banks are also responding but with more restrained rate movements.

• Across the board—declining CASA, thinning NIMs, and external rate pressures—showcasing that this shock isn’t isolated but systemic.

  
  

  Different balance sheets, different strategies… but the same widening gap. And with ₹2 trillion recently parked in the RBI’s reverse repo window, the pressure to deploy is only mounting.

🎯 Purpose

This isn’t just about one rate cycle. It’s about a structural quirk in banking that surfaces every time the RBI shifts gears.

Asset–liability repricing gaps are baked into the system. Loans reprice fast. Deposits reprice slow. And in the gap between the two, profitability bleeds.

For policymakers, aggressive rate cuts are meant to spur lending. For banks, those same cuts can trigger a short-term profitability trap — forcing them to choose between holding idle cash or lending at wafer-thin margins.

The cycle repeats. Different years. Different macro triggers. Same squeeze.

💡 Does Policy Always Deliver?

In theory, a repo rate cut should speed up lending and boost growth. In practice, the squeeze between fast-falling loan rates and slow-moving deposit costs can blunt the intended effect — at least in the short term. Liquidity alone doesn’t guarantee credit flow; confidence, demand, and risk appetite matter just as much.

♻️ Why the Cycle Repeats

We’ve seen this movie before. In 2020, in 2015, even in 2009.The RBI still uses the same rate-cut playbook because it’s the fastest, most visible way to boost liquidity economy-wide.

Yes, the asset–liability lag hurts banks in the short run.But from a policy perspective, if credit growth eventually rises and the economy steadies, the short-term pain is considered an acceptable trade-off.

Until the structure of deposits and lending changes in India, the same script will keep playing out.

🔮 What’s Next?If 2020 is any guide, the next 2–3 quarters could follow a familiar path:

• NIM compression deepens in the immediate term as deposit repricing lags further behind lending rate cuts.

• Corporate borrowers lock in ultra-low rates on long-tenor loans, limiting scope for yield recovery even when rates eventually rise.

• Shift towards retail and SME lending accelerates — partly to protect spreads, partly to diversify away from corporate rate pressure.

• Deposit competition heats up once liquidity begins to tighten again, eroding cost-of-funds gains achieved in the interim.

In 2020, it took nearly four quarters for most banks to fully realign deposit costs with lower loan yields.If history repeats, margins could stay under pressure well into mid-FY27 — even if policy rates remain stable from here.

If you’ve worked through a rate-cut cycle, you’ve probably felt this squeeze first-hand.Maybe you were on the lending side, fielding corporate negotiations.

Maybe you were managing deposits, waiting for cost relief to trickle in.

How did your organisation play it? Clear “old stock” quickly? Push high-margin segments?Or just ride it out?

Drop your thoughts below — because while the cycle may be predictable, the playbooks can be very different.