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Lower lending rates likely to stress banks' margins

But with deposit rates staying firm, most banks are likely to see a dip in their NIMs

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Banks' are set to become inexpensive following the cut in repo rate after a gap of nine months. But with deposit rates staying firm most banks are likely to see a dip in their net interest margins in coming quarters.

The Reserve Bank of India (RBI) today reduced the repo rate by 25 basis points. It also pared the cash reserve ratio (CRR) by a similar margin to persuade banks in lowering their lending rates in a tight liquidity environment.

"Some banks said their margins will come under pressure. But the overall message we got was monetary policy transmission will take place. We are confident of transmission taking place because of the CRR cut. We had discussed it internally and the decision was to ensure monetary policy transmission we should do a CRR cut," RBI governor D Subbarao said following the central bank's third quarter review of monetary policy for 2012-13.

The CRR cut will inject Rs 18,000 crore of primary liquidity in the system and offer banks additional money to lend. But not many were impressed. "I would have preferred an even larger cut in CRR, as it could have delivered a significant multiplier effect on liquidity and could have made transmission of rates a lot easier," Shyam Srinivasan, managing director and chief executive of Federal Bank, said.

The liquidity conditions have tightened from the second week of November due to a build-up in the government's cash balances, festival-related increase in currency demand, and widening gap between deposit and credit growth.

"We are facing a flight of deposits. We have mentioned this to governor. We are losing money to mutual funds. Today, banks are loaded with handicaps. Our interest is taxed at highest marginal rate whereas mutual fund investments, even in debt funds, are taxed at benign rates," Pratip Chaudhuri, chairman of State Bank of India (SBI), said.

While bankers said that reduction in lending rates was inevitable, they expressed doubts in their ability to cut deposit rates as liquidity conditions remain tight.

Only a week back a few lenders like ICICI Bank and Axis Bank have increased their deposit rates. "You may find a difference in the pace at which deposit rates and lending rates move. It is not necessary to assume that if lending rates go down deposit rates will also fall automatically," Chanda Kochhar, managing director and chief executive officer of ICICI Bank, said.

Bankers agreed that their margins are likely to narrow if lending rate cuts are not accompanied with reduction in deposit rates. "You cannot say that there will not be any impact on net interest margin. It will be impacted. But we will have to find out ways to manage it," SS Mundra, chairman and managing director of Bank of Baroda, said.

However, lenders were hopeful that they will be able to restrict the erosion in their margins once liquidity conditions improve. "There are pressures on net interest margins. Banks may not be able to absorb it indefinitely. It is a complicated situation and banks will try to find avenues to reduce their deposit rates and keep margins steady," KR Kamath, chairman and managing director of Punjab National Bank, said.

A similar view was echoed by Kochhar. "The indication that you are getting from everybody is that on the lending side there will be transmission and on the deposit side they are going to watch the situation. That is probably the best news for small customers. Clearly in the long term banks cannot continue this and it will get adjusted," she said.

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