TOPIC:
INTERCONNECTED ROLE OF RBI AND FINANCIAL INTERMEDIARIES:
Analysing the Impact of Repo Rate on Bank Lending in India
By: Sakshi Sharma
(2023CE11043)
I. BACKGROUND
A financial system's fundamental purpose is to efficiently facilitate the flow of funds. It channels
money from individuals and entities with surplus capital (Surplus Spending Units or SSUs) to those
with a need for funds for investment or expenditure (Deficit Spending Units or DSUs). The
efficiency of this process has a direct impact on economic output and overall welfare.
➢ The financial system performs five primary functions:
• Facilitating the flow of funds.
• Providing a mechanism for the settlement of transactions.
• Generating and disseminating information to assist decision-making.
• Providing a means for the transfer and management of risk.
• Dealing with incentive problems that arise in financial contracting.
➢ The Role of Monetary Policy and Financial Intermediation:
In India, the Reserve Bank of India (RBI) plays a pivotal role in managing this system using its
monetary policy. A key tool for the RBI is the repo rate, which is the interest rate it charges
commercial banks for short-term loans. This rate essentially sets the tone for the entire market.
The repo rate is currently 5.50% as of August 2025, a reduction made by the RBI's Monetary Policy
Committee to support economic growth. This rate change is intended to influence the lending
behaviour of financial intermediaries, particularly commercial banks. Banks operate by taking
deposits from SSUs and providing loans to DSUs, earning a profit on the spread between the interest
paid and the interest charged. A lower repo rate reduces a bank's cost of borrowing, encouraging
them to lend more freely and at lower rates to increase this spread and generate more income.
➢ The Indian Context: An Analysis of Borrowing and Risk (From the slides)
Looking at recent data, we saw a significant rise in borrowing across the Indian economy. Household
debt, for instance, climbed to 17.1% of GDP in March 2024, up from 14.9% a year earlier. At the
same time, credit from Non-Banking Financial Companies (NBFCs) has also surged, hitting 26%
of GDP in FY25, which shows their growing role in providing loans to sectors like MSMEs and
retail borrowers.
This upward trend makes it crucial to analyse the connection between the RBI's policy rates and the
lending behaviour of financial institutions. This project examines how these changes in the repo rate
are transmitted through the financial system and how they affect borrowing levels. We also applied
concepts like the risk-return mismatch and moral hazard to understand the potential implications
of this trend on the stability of the Indian financial market.
II. DATA
The analysis of the relationship between the RBI's monetary policy and the Indian financial system
requires the collection of key macroeconomic and financial data. This data is sourced from credible
national and international institutions to ensure accuracy and reliability.
We have collected data for the last five years, from the financial year 2021 (FY21) to 2025 (FY25),
to capture a recent period of significant monetary policy adjustments.
Data Sources and Metrics:
1. RBI Policy Rate: The RBI's website is the definitive source for historical policy rates. We have
collected the repo rate as a primary measure of the RBI's monetary policy stance. For instance,
the repo rate was 4.00% in early 2021 and has since increased before being reduced to its
current level of 5.50% as of August 2025.
2. Bank Lending Rates: To see how policy changes are transmitted to the market, we used the
Marginal Cost of Funds Based Lending Rate (MCLR) from a major public sector bank like
the State Bank of India (SBI). This data is publicly available on the bank's website. The 1-year
MCLR is a common benchmark for many loans and provides a direct comparison to the repo
rate.
• [Link]: This link has graph of RBI repo rate and SBI 1-year MCLR to compare.
3. Household Debt: To measure the response of borrowers to these rates, we tracked household
debt as a % of GDP. This data is available from sources like CEIC Data and the Bank for
International Settlements (BIS). This metric showed the overall level of household leverage in
the economy. As per recent data, household debt has risen to 17.1% of GDP in March 2024
from 14.9% a year prior, which is a key trend we analysed.
4. NBFC Credit Growth: We also included data on the Non-Banking Financial Companies
(NBFC) credit as a percentage of GDP. This information can be found in financial reports and
news outlets like Zee Business, which cited a report by Ionic Wealth. This metric illustrated the
increasing role of NBFCs in the credit ecosystem, with their credit to GDP ratio rising to 26% in
FY25, up from approximately 16% in FY19.
III. METHODOLOGY
The objective of this project is to analyse the relationship between the RBI’s monetary policy and
the lending behaviour of commercial banks in India. To achieve this, we used a quantitative and
comparative methodology, applying the theoretical concepts of financial market functions discussed
in our course to the data collected.
1. Analysis of Monetary Policy Transmission
The first part of the analysis focused on the monetary transmission mechanism—the process by
which a central bank's policy actions, such as changing the repo rate, are passed on to the broader
economy. Using the combined line chart of the RBI Repo Rate and the SBI 1-Year MCLR, we
performed a visual and descriptive analysis.
• Visual Analysis: We examined the chart to pinpoint when the RBI changed the repo rate. For
example, we looked at the hikes from May 2022 to February 2023. Then, we saw how the SBI's
MCLR reacted. Our expectation was to find a direct correlation, where the MCLR moves in the
same direction as the repo rate.
• Lag Analysis: A key aspect of monetary transmission is the lag between the RBI's decision and
the market's response. We analysed the time it took for the MCLR to adjust after a change in the
repo rate. This helped us gauge how quickly policy signals are passed on.
2. Analysis of Lending and Borrowing Trends
The second part of the methodology connected the interest rate analysis to real-world borrowing
behaviour. Using the chart of Household and NBFC credit-to-GDP ratios, we looked for correlations
between periods of low interest rates and increased borrowing.
• Correlation with Interest Rates: We evaluated if the increase in household debt and NBFC
credit correlates with the period when interest rates were historically low (e.g., the 4.00% repo
rate maintained from May 2020 to April 2022). A strong inverse relationship—where low rates
lead to higher borrowing—validated the theoretical concept that cheaper funds encourage greater
expenditure and leverage.
• Role of Financial Intermediaries: This section linked the data to the functions of financial
intermediaries. We discussed how banks and NBFCs, by providing easy access to credit,
facilitate the flow of funds and take on risks. The increase in NBFC lending, which grew at a
faster CAGR than banks between FY20-FY25, highlights their increasing role in financial
intermediation and their potential impact on financial stability.
3. Application of Theoretical Concepts
Finally, we applied the theoretical concepts learned in class to the findings from our data analysis.
• Risk and Return: We discussed how prolonged low interest rates can create a "risk-return
mismatch," where investors and lenders may not be appropriately compensated for the risks
they take, potentially leading to increased lending to riskier borrowers.
• Incentive Problems: The analysis touched upon moral hazard and adverse selection. The
availability of cheap funds and the potential for banks to pass off credit risk through
securitization (though not the focus of this project) can create incentives for less prudent lending.
IV. REFERENCES
• Household debt: India Household Debt: % of GDP, 1998 – 2025 | CEIC Data
• Repo Rate: [Link]
• SBI 1-Year MCLR: SBI - Loans, Accounts, Cards, Investment, Deposits, Net Banking - Personal
Banking
• ZEE Business, NBFC Credit growth: NBFC credit to GDP has increased to 26 per cent in FY25,
continues to outpace banks: Report | Zee Business
• Lecture Slides
