Banks are likely to reduce their interest rates on home loan, personal, auto loans and corporate borrowings once they notice the effect of rate cut in their books. Lending rates of the banks are expected to drop by 1% to 2% by the end of December.

Managing Director of ICICI, K V Kamath said that banks will transfer the benefits of home loan interest rates reduction to their borrowers after it is reflected in their books. He says that the market is signaling a rate cut of 1.5% in the yields of 10 year government bonds and 1.5% to 2% drop in one-year term deposits. Besides the inflationary pressure is also expected to be below 5% that urges a sharp rate cut across-the-board.

"Lending rates and borrowing rates do not change so quickly. The banks should be sure that interest rates are reducing and that should be reflected in our books. The banks will understand that the rates are really coming down in a few more weeks. I can clearly see the prices coming down," said Mr Kamath.

Reserve Bank of India has cut its policy rates indicating banks to reduce lending rates and further give some space to allow banks to cope up with the slowing economy. Although RBI has taken a move to encourage banks to offer cheaper loans but most banks are following a policy of wait-and-watch before cutting down their lending rates. They are hesitant because of the rising defaults in retail, SME and corporate loans.

Country's largest private lender, ICICI Bank has scaled down its growth plans for this year but is yet to decide on its lending and deposit rates. It has only reduced lending rates on new home loans of up to Rs 20 lakh by 150 basis points to 11.5%. On the other hand, almost all public sector banks have sliced their lending rates in the backdrop of measures taken by RBI.

The average prime lending rates of major public sector banks lie in the range of 13.75% to 14%. Until now only three banks including HDFC Bank, Union Bank of India and Yes Bank have declared a cut in their prime lending rate after the RBI's announcement of a 100 basis points reduction in its short term key policy rates.

The interest rates are however expected to drop in line with the market trend. "A trend is set for the interest rates to follow," said Mr Kamath. He further deemed that any player who does not resort to a rate cut will not be competitive and therefore "all banks will have to play ball."

Conversely several PSU banks that have declined their home loan rates said that they will now reduce the lending rates only if they receive a financial support from the government. They are seeking for subvention in the form of an interest rate subsidy because if they lower lending rates below the one-year deposit rates then they end up making losses in their books.