Understanding the Impact of Interest Rates on Credit Growth

A recent study by the Boston Consulting Group (BCG) sheds light on the complex relationship between interest rates and credit growth in India. Contrary to popular belief, the report finds that low rates do not automatically lead to an increase in lending. Instead, credit growth is more influenced by borrower sentiment and lender confidence.

The Role of External and Domestic Factors

The Reserve Bank of India (RBI) has adjusted the repo rate significantly in recent years, reflecting the balancing act between stimulating growth and controlling inflation. However, the BCG report highlights that external risks, such as geopolitical tensions and global financial imbalances, now play a more critical role in shaping India's interest rate policies than domestic considerations.

Recommendations for Banks

BCG advises banks to move away from linear forecasting and adopt more dynamic, scenario-based planning. The report also calls for an overhaul of internal pricing frameworks, emphasizing the need for marginal cost-based pricing and better balance sheet simulations to align profitability and capital allocation more effectively.