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BCG Sounds Alarm: Indian Banks Enter Era of Heightened Interest Rate Volatility
After more than a decade of relatively stable interest rates, Indian banks are entering a new phase of "heightened interest rate volatility," according to a critical report by the Boston Consulting Group (BCG). Titled "Interest Rate Sensitivity in Indian Banking," the study released recently, urges banks to move beyond linear forecasting and embrace scenario-based planning to navigate this evolving landscape.
Lagged and Non-Uniform Impact of Policy Rates
The report highlights a crucial insight: the impact of policy rate changes by the Reserve Bank of India (RBI) on bank performance is neither immediate nor uniform. Empirical data shows that credit growth, for instance, is influenced more by borrower sentiment and lender confidence than solely by interest rates. Despite declining rates between 2014-2016 and 2018-2020, credit growth remained weak, while lending surged in 2022-2023 amidst rising rates. This suggests that unless credit demand is robust, rate cuts typically require 18-24 months to significantly boost lending.
Key Findings from the BCG Report:
- Delayed Transmission: Repo rate changes take a substantial 12-24 months to fully influence key banking metrics such as credit, deposits, and Net Interest Income (NII). This lag makes short-term reactive strategies ineffective.
- PSBs More Responsive: Public Sector Banks (PSBs) exhibit greater responsiveness to repo rate changes, particularly in advances growth, compared to private banks. A 50 basis point repo hike, for example, led to a 1.4% increase in advances for PSBs, compared to 1.16% overall.
- Deposits Less Sensitive: Surprisingly, deposit mobilization shows little direct correlation with interest rates. Factors such as customer engagement, fierce competition, and robust liquidity management play a more significant role. PSBs, with their historically stable depositor base, are particularly less affected by rate fluctuations in terms of deposit growth.
- NII Highly Rate-Sensitive: NII, the core profitability metric for banks, is highly sensitive to interest rates. A 50 basis point increase in the repo rate boosted NII by 1.11% across all scheduled commercial banks, and by 1.45% for PSBs. Conversely, rate cuts predictably lead to income declines, necessitating proactive balance sheet management.
Strategic Implications for Banks
BCG strongly recommends that Indian banks revamp their internal pricing frameworks, which currently rely too heavily on historical cost of funds. A strategic shift towards marginal cost-based pricing and enhanced balance sheet simulations is deemed essential for optimal profitability and capital allocation in a volatile rate environment. Furthermore, with Indian savers increasingly exploring alternative investment avenues like mutual funds, pensions, and direct investments, banks must leverage data science to better understand and cater to evolving depositor behavior.
This report serves as a timely warning and a strategic blueprint for the Indian banking system, emphasizing the need for agile and data-driven approaches to thrive in a more volatile interest rate environment, ultimately benefiting both financial institutions and their customers across India, including those in Prayagraj.