The Reserve Bank of India (RBI) began pumping money into the banking system in December 2024, while the Monetary Policy Committee (MPC) started cutting interest rates in February. However, the MPC’s 100 basis points (bps) of rate cuts and the lakhs of crores of money provided by the RBI to the banking system has had little impact on demand for loans. In fact, credit growth has almost halved from the middle of 2024. And economists think loan growth may fall further in the coming months.
According to data released on June 30 by the RBI, non-food credit extended by Indian banks was up 9.8 per cent year-on-year (YoY) as at the end of May, down from 11.2 per cent in April and 16.2 per cent a year ago, after excluding for the impact of the merger of HDFC Bank with Housing Development Finance Corporation in July 2023.
The sector-wise breakdown makes for similar reading. Take loans to industry, for instance, which showed a growth of just 4.9 per cent YoY at the end of May, down from 6.7 per cent in April and 8.9 per cent a year ago.
At the same time, the amount of money the RBI has pushed into the banking system has ballooned. It first cut banks’ Cash Reserve Ratio (CRR) by 50 bps in December 2024, after which — through a variety of instruments, such as purchases of government bonds — the Indian central bank added nearly Rs 10 lakh crore into a system that was tight on cash starting the second half of 2024 due to tax outflows and the RBI’s own operations in the foreign exchange market.
And while the rupee stabilised before the RBI loosened its grip somewhat in 2025, demand for bank loans has continued to weaken even as borrowing costs have fallen. According to RBI data, new bank loans were around 20 bps cheaper in May compared to a year ago.
Wasted liquidity surplus?
According to J.P. Morgan economists, the continued addition of liquidity into the banking system by the RBI is a futile attempt to bring down lending rates of banks — beyond a point.
In a note published earlier this month, the investment bank’s economists said “there is no evidence that liquidity ‘causes’ credit or deposit growth. If anything, the causality is reversed, with credit driving liquidity growth, through the deposit and Cash Reserve Ratio channel.” As per its analysis, J.P. Morgan found that the entire impact on banks’ lending rates from changes in banking system liquidity is because of movements in the interest rate at which banks lend to each other — the ‘call rate’. As such, once the call rate declines to a certain level, there is no incremental benefit in terms of a further decline in banks’ lending rates from the provision of additional liquidity by the RBI.
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The central bank, seemingly, has taken note of this too, and in recent days looked to suck out the excess money it has pumped into the banking system. Since June 27, the central bank has removed almost Rs 7 lakh crore. However, given the temporary nature of these operations, much of these removed funds are already back with banks.
But even before the RBI began conducting these temporary operations — called variable rate reverse repos — to drain out excess money, banks were already keeping them at a central bank facility in return for a fixed rate of interest of 5.25 per cent. However, the amount banks were choosing to keep at this so-called Standing Deposit Facility has more than quadrupled in the last one year — from a daily average of Rs 58,817 crore in June 2024 to Rs 2.59 lakh crore in June 2025. Clearly, there are few takers for loans from banks.
Will the weak loan growth continue?
Weakness in demand for loans has been a concern for the MPC, which cut the policy repo rate by a larger-than-expected 50 bps to 5.5 per cent on June 6 to push banks to cut their lending rates faster. But this ‘transmission’ of policy rate cuts to lending rates of banks — which can take up to one year, although the RBI over the years has tried to make this process faster — depends on a variety of factors.
According to Nomura economists Sonal Varma and Aurodeep Nandi, a faster and more complete transmission of changes to the policy repo rate requires not just excess money in the banking system but also a lower credit-deposit (CD) ratio, which is an indicator of the proportion of a bank’s deposits sent out as loans.
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“The periods of maximum pass-through of policy rate cuts have typically happened in periods when the credit-deposit ratio was much lower in the 70-74 per cent range,” Varma and Nandi said in a report on July 8, adding that the ratio was currently just below 80 per cent. According to them, the RBI’s latest bank lending survey is indicative of moderating demand for loans, especially for retail and personal loans, while the global trade uncertainty coupled with rising imports from China is keeping industrial capacity utilisation subdued. As a result, Varma and Nandi see credit growth falling even further to 7-8 per cent by March 2026.
Need for loan demand
As RBI Governor Sanjay Malhotra noted on June 6, for banks to lower their lending rates, there needs to be demand for loans. And demand for loans depends on the macroeconomic conditions and appetite for credit. Clearly, the fact that the RBI has felt the need to inject so much money into the banking system and reduce the policy repo rate by 100 bps in a matter of months is a sign of weakness in macroeconomic conditions — even if the annual GDP growth rate is seen stable around 6.5 per cent.
“…credit demand follows the momentum in economic activity and often continues to rise despite a rise in interest rates. The reverse is also empirically observed. If credit demand is moderate, a reduced interest rate may not boost it over the next 12-24 months. For any impact, it is critical to hold the rate steady for 18-24 months,” the Boston Consulting Group said in a report this month.
