Loan Spreads Widen in May as Banks Focus on Protecting Margins

Indian Banks Widen Loan Spreads Amid Repo Cuts

Banks in India are changing how they lend once again. By the end of May 2025, the lending landscape had shifted. Following three repo rate cuts in a row, most banks have increased their loan spreads to protect thinning margins.

What began as a quiet response to higher deposit costs is now a clear strategy adopted by both private and public banks.

According to a June 2025 update from the Reserve Bank of India (as reported by the Economic Times), the average spread on new rupee loans rose by 17 basis points in May, reaching 3.09 per cent.

This happened even as banks reduced deposit rates more sharply than lending rates, giving lenders some room to preserve their net interest margins.

Private Banks Lead in Spread Expansion

Private lenders acted fast. Their average spread for new loans widened by 34 basis points to 3.86 per cent in May. Public sector banks, while slower, also raised their spreads, but by a modest 6 basis points to 1.79 per cent. 

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The move highlights how private banks often shift pricing more aggressively than their public counterparts.

The difference in approach stems from the way each group manages its funding. Private banks depend more on short-term deposits, which are sensitive to rate movements. 

Public banks carry more legacy deposits and follow stricter lending norms, which makes them slower to react.

Deposit Rates See a Quiet Reduction

While loan spreads expanded, fresh deposit rates fell. Banks lowered interest on fresh deposits by 23 basis points in May, bringing the average rate down to 6.11 percent. Outstanding deposits saw a smaller drop, down just 4 basis points to 7.07 percent.

The drop in deposit rates shows that banks were quick to cut funding costs before the full transmission of repo rate reductions hit lending portfolios. Most of the fall came from term deposits of less than one year.

But the impact didn’t stop there. The central bank noted in the same report that banks are still dealing with delayed transmission on loans linked to internal benchmarks like MCLR. This causes spreads to widen artificially during the transition period.

RBI Flags Mixed Signals in Credit Growth

The RBI’s Scheduled Banks’ Statement of Position in India report dated June 21, 2025, revealed that bank credit to industry fell sharply in the fortnight ending May 30. Growth dropped to 4.9 per cent year-on-year, compared to over 8 per cent in the same period last year. 

Non-food credit growth also slowed to 9.8 per cent. These numbers show that despite wider spreads, loan demand remains weak.

This slowdown indicates that banks are not just protecting margins; they are also holding back credit. With falling appetite in sectors like infrastructure, manufacturing, and trade, lending is being selectively filtered to reduce risk.

In the next section, let’s look at what the global trend says about such shifts.

Global Shift Towards Fee-Based Revenue

This change in strategy is not unique to India. The European Central Bank’s Financial Stability Review released in May 2025, pointed to the same. Banks across Europe have started focusing more on income from service fees, investment banking, and transaction charges. With interest margins under pressure globally, income is now being built through customer relationships and non-loan services.

Though Indian banks have not spoken publicly about a similar move, several analysts expect a gradual rise in fee-based models in the upcoming quarters. This includes charges on digital banking, remittances, loan processing, and card-based services.

What’s Behind the Delay in Loan Rate Cuts?

According to the RBI’s internal rate transmission dashboard, the share of floating loans benchmarked to the External Benchmark Lending Rate (EBLR) was 61.6 percent as of March 2025. The rest, roughly 35 per cent, was still tied to MCLR, which reacts slower to policy rate changes.

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This creates a situation where deposit rates fall faster than lending rates. So banks widen spreads temporarily until all loans adjust.

Here’s a breakdown of current loan linkages:

This imbalance has kept fresh loan pricing higher for longer, even as RBI has cut policy rates by 100 basis points since February.

Conclusion 

The widening of loan spreads in May shows how banks are now being careful with both credit flow and margin planning. The RBI’s reports confirm the trend, but they also hint at deeper shifts in bank behaviour. The slowdown in lending, the sharper move by private banks, and the quiet drop in deposit rates, all point to a banking system that is adjusting, not reacting.

In the coming months, much will depend on how inflation behaves and how credit demand from businesses shapes up. Until then, margins will stay at the heart of banking strategy.
 

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