The yield disconnect: why repo rate cuts aren’t lowering borrowing costs

A recent economic report from Ambit Capital, dated February 13, 2026, highlights a critical disconnect in India’s financial markets: despite a cumulative 125bps reduction in the repo rate since February 2025, benchmark bond yields remain stubbornly elevated.

This "liquidity tree" phenomenon is primarily driven by structural tightness within the banking system and a widening gap between credit and deposit growth.

The Sticky Yield Paradox

While the Monetary Policy Committee (MPC) aimed to lower borrowing costs, the 10-year G-Sec yield has actually risen during the easing cycle—the first time this has occurred in over two decades. As of early February 2026, the spread between the repo rate and benchmark yields stood at approximately 150bps.

This disconnect is fueled by:

Bank Portfolio Shifts: Banks are prioritising credit deployment over government securities (G-Secs) to support robust credit demand.

Low G-Sec Appetite: In CY25, banks net purchased only ₹2.9 trillion in G-Secs, a sharp decline from ₹6.1 trillion in CY24.

Regulatory Constraints: New HTM (Held-to-Maturity) regulations limit banks' ability to rebalance their portfolios, reducing their incentive to purchase new G-Secs.

The Credit-Deposit Crunch

The banking sector is facing significant funding stress as credit growth (13.1%) continues to outpace deposit accretion (10.6%). This gap of ~250bps pushed the system-wide credit-deposit (CD) ratio to 82% in January 2026.

Ambit Capital notes that "money isn't becoming deposits" partly because households are shifting savings toward equities and mutual funds. Additionally, National Savings Schemes, offering rates as high as 7.7%, remain more attractive than bank deposits (averaging 5.5%), further draining retail liquidity.

RBI’s Proactive Role

To prevent a credit crunch, the Reserve Bank of India (RBI) is shifting from a reactive to a "pro-active" stance. Key liquidity-injecting measures include:

Open Market Operations (OMOs): The RBI has already conducted ₹4 trillion in OMO purchases between November 2025 and January 2026.

Potential CRR Cut: There is scope for a further 50bps cut to the Cash Reserve Ratio (CRR), which could inject an additional ₹1–1.3 trillion into the system.

Forex Headroom: Recent trade agreements (including a prospective US-India deal) are expected to stabilise the rupee, allowing the RBI to scale back liquidity-draining forex interventions.

Sector Outlook and Strategy

Despite liquidity pressures, credit demand remains strong, particularly in MSME and unsecured retail segments. However, banks may face pressure on Net Interest Margins (NIMs) as they pivot toward costlier wholesale funding, such as Certificates of Deposit.

Ambit Capital maintains a preference for large-cap banks focused on profitable growth, ranking them as follows: HDFC Bank > ICICI Bank > Axis Bank/SBI.