The Reserve Bank of India’s decision to hold interest rates steady reflects a delicate balancing act between supporting economic growth and managing financial risks amid global and domestic influences. Experts warn that persistently low real rates may encourage risky lending, highlighting the need for tighter risk monitoring alongside easier credit policies.
The Reserve Bank of India’s decision on August 5 to leave interest rates unchanged and keep a neutral policy stance was, on the face of it, a cautious one. Yet the case for holding steady was strengthened by softer oil prices, helped by renewed US-Iran peace talks, and by a July monsoon that has been better than expected, both of which ease pressure on inflation. The IMF has also projected that Indian inflation will rise to 5.9% in the third quarter of fiscal 2025-26, suggesting the central bank is still operating in an environment where price pressures are manageable but not negligible.
The deeper logic behind the pause is real interest rates. By keeping policy unchanged while inflation is expected to edge higher, the RBI is allowing borrowing costs in real terms to stay low, which supports credit growth and demand. That matters for an economy trying to sustain growth above 7%. Credit to small and medium-sized businesses as well as households has already recovered strongly since late 2025, when expected real rates began to fall.
But low real rates come with a known danger: they can encourage banks to take on more risk. Research by Gabriel Jiménez, Steven Ongena, José-Luis Peydró and Jesús Saurina, based on more than 23 million loans in Spain, found that prolonged periods of low real rates after the global financial crisis pushed weaker banks towards riskier borrowers, lighter collateral requirements and eventually higher defaults. Similar patterns have been identified in the US and parts of Europe, and the article’s authors say their own work using India’s Ministry of Corporate Affairs credit registry points to comparable behaviour by Indian banks in the first half of the 2010s, when low real rates fed into the non-performing asset crisis.
The mechanism is straightforward. When lending margins shrink, banks are pushed to search for higher-yielding borrowers, who are often also riskier. Lower profitability can also reduce the incentive to spend on screening and monitoring, because those are relatively fixed costs. At the same time, cheaper money lifts the value of bond holdings and collateral, which can make balance sheets look stronger than they really are and encourage further risk-taking.
That is why the broader argument is not against easier credit, but against relying too heavily on low real rates as the main way to deliver it. The structural problem in Indian finance is the cost of identifying, assessing and monitoring creditworthy borrowers, and that cost is embedded in lending rates. Public digital infrastructure has already shown how much can change: the National Payments Corporation of India created transaction trails that help lenders assess cash flows, while the RBI’s Unified Lending Interface could extend that model further. In that sense, better financial intermediation can make good borrowing cheaper without also making bad borrowing more attractive. The RBI’s present position may be defensible, but the article argues that policymakers should pair it with tighter risk monitoring if they want growth without paying too high an inflationary price.
Disclaimer: This article is intended to inform and educate, not to recommend or endorse any financial product, investment or strategy. Please consider your own financial circumstances and seek professional advice where appropriate before making financial decisions.
