RBI Holds Repo Rate at 5.25%, But Why Bank Margins May Remain Under Pressure

The Reserve Bank of India kept the repo rate unchanged at 5.25% in its August 2026 monetary policy meeting. The central bank also retained its neutral policy stance.

At first glance, the pause may appear positive for banks. A stable repo rate means lending rates may stop falling sharply, which could help banks protect their interest income.

However, the impact of previous rate cuts is still moving through the banking system. Loan rates have declined faster than deposit rates, credit growth remains stronger than deposit growth, and the banking sector’s net interest margin has already started moderating.

For bank investors, the important question is not simply whether the RBI has stopped cutting rates. The real question is how long banks will continue to face the impact of earlier cuts.

RBI August 2026 Policy Highlights

The RBI’s Monetary Policy Committee unanimously decided to:

• Keep the repo rate unchanged at 5.25%
• Retain the standing deposit facility rate at 5.00%
• Keep the marginal standing facility rate and Bank Rate at 5.50%
• Continue with a neutral monetary policy stance
• Maintain FY27 GDP growth projection at 6.7%
• Project FY27 CPI inflation at 5.0%

The RBI said inflation is expected to rise in the near term, mainly because of food and fuel prices. At the same time, core inflation excluding precious metals remains relatively low.

This gave the RBI room to avoid raising rates, but uncertainty around crude oil, rainfall, food inflation and the West Asia conflict prevented another immediate rate cut.

Why Does the Repo Rate Matter for Banks?

Banks primarily earn money by accepting deposits and lending that money to borrowers at a higher interest rate.

The difference between the interest earned on loans and the interest paid on deposits is reflected in the bank’s net interest margin, or NIM.

A higher NIM generally means that a bank is earning more from its lending business relative to its interest-bearing assets. A falling NIM means that the gap between loan income and funding costs is narrowing.

When the RBI cuts the repo rate, loan rates generally decline. This is helpful for borrowers, but it can put pressure on bank earnings if deposit costs do not decline at the same speed.

That is exactly where the current pressure is building.

Loan Rates Have Fallen Faster Than Deposit Rates

The RBI reduced the repo rate by a cumulative 125 basis points between February 2025 and June 2026.

However, the decline in lending and deposit rates has not been equal.

Outstanding loan rates have declined by 91 basis points, while rates on outstanding deposits have fallen by only 51 basis points.

This means the return banks earn from existing loans has reduced faster than the interest cost on their existing deposits.

Even though the RBI has now paused, the full impact of previous rate cuts may continue to appear in bank earnings as more loans are repriced at lower rates.

At the same time, banks may find it difficult to reduce deposit rates aggressively because they still need deposits to support credit growth.

Credit Is Growing Faster Than Deposits

The second source of pressure is the gap between credit and deposit growth.

Bank credit increased 18.6% year-on-year in June 2026, while deposits increased 13.3%.

The RBI also reported that overall bank credit was growing 17.7% year-on-year as of July 15, 2026, compared with 9.9% a year earlier.

Strong credit growth is generally positive because it allows banks to increase their loan books and generate more interest income.

However, banks need stable funding to provide these loans. Deposits are one of the most important and generally lower-cost sources of funding.

When loans grow much faster than deposits, competition among banks for customer deposits can increase. Banks may need to continue offering attractive rates on fixed deposits to raise enough money.

This limits their ability to reduce deposit costs, even when policy rates are no longer falling.

Therefore, the same strong credit growth that supports bank revenue can also create pressure on funding costs and margins.

Margin Pressure Has Already Started Appearing

The banking system’s net interest margin declined from 3.26% in June 2025 to 3.21% in June 2026.

The decline of five basis points may appear small. But the direction is important because it shows that the difference between lending income and funding cost has started narrowing.

The margin pressure could continue if:

• Existing loans continue to reset at lower interest rates
• Deposit rates remain elevated because of competition
• Credit continues to grow faster than deposits
• Banks increase their dependence on higher-cost term deposits
• Borrowers shift towards lower-yielding loan products

The RBI itself noted that transmission to fresh lending rates had moderated recently because credit demand remained strong. However, that does not completely remove the pressure created by earlier loan repricing.

Does This Mean Bank Earnings Will Decline?

Not necessarily. NIM is an important part of bank profitability, but it is not the only factor that determines earnings.

Banks can partly offset margin pressure through faster loan growth. If the loan book expands strongly, total interest income can still increase even if the margin earned on each rupee of assets declines slightly.

Banks can also protect profitability through:

• Higher fee and commission income
• Lower operating costs
• Better loan recovery
• Lower provisions for bad loans
• Stronger growth in higher-yielding segments
• Better management of deposit and borrowing costs

The banking system’s asset quality also remains healthy.

Gross non-performing assets improved from 2.22% in June 2025 to 1.68% in June 2026. Net non-performing assets declined from 0.51% to 0.40%.

Return on assets improved slightly from 1.30% to 1.32%, while return on equity increased from 13.02% to 13.23%.

This means banks are entering the margin-pressure period with stronger asset quality and stable profitability. Lower bad-loan provisions could provide some support even if interest margins weaken.

Not All Banks Will Be Affected Equally

The impact of the rate cycle will vary significantly across banks. Banks with a strong base of low-cost savings and current account deposits may be better placed because they rely less on expensive fixed deposits.

Banks that can increase deposits in line with loan growth may also face less pressure than banks that are expanding credit aggressively without matching deposit growth.

Investors should also examine the loan mix. Banks with better pricing power or a larger share of higher-yielding loans may have more room to protect their margins.

On the other hand, banks that depend heavily on term deposits, wholesale funding or aggressive deposit rates may face greater pressure.

The size of the bank alone may not determine the outcome. Deposit quality, loan pricing, customer retention and balance-sheet discipline will matter more.

Can the RBI Cut Rates Again?

The RBI has retained a neutral stance, which means it has not committed to either raising or cutting rates. Future policy decisions will depend on the inflation and growth outlook.

The RBI expects CPI inflation to increase to 5.9% in Q3 FY27 before moderating. Food prices, fuel costs, crude oil volatility and deficient rainfall remain key risks.

If inflation moderates after the expected peak, the possibility of another rate cut could return. However, another cut would again put downward pressure on lending rates and could extend the margin challenge for banks.

A prolonged pause, on the other hand, would allow banks more time to reduce deposit costs and adjust their balance sheets.

Author’s Take

The RBI’s decision to keep the repo rate unchanged at 5.25% provides some near-term stability, but it does not immediately solve the banking sector’s margin problem.

Banks are still absorbing the impact of the previous 125-basis-point rate reduction. Loan rates have fallen faster than deposit rates, while credit is growing faster than the deposit base needed to fund it.

This creates a difficult balance. Banks need to keep loan growth strong, but they also need to protect margins without losing deposits or borrowers.

The positive is that the banking system’s asset quality, capital position and profitability remain healthy. This reduces the risk of a broader banking-sector problem.

For investors, the next phase is likely to be about stock selection rather than treating all banks similarly. Banks with strong deposit franchises, controlled funding costs, disciplined loan growth and stable asset quality are likely to manage the pressure better.

The repo-rate pause may slow the margin decline, but the real recovery will depend on whether deposit costs begin falling faster than loan yields.