Lending rate cuts likely to put pressure on banks' margins

Private lenders seen better poised to protect margins

In the wake of the Reserve Bank of India’s (RBI) rate reversal signal, the ongoing and impending reductions in banks’ base rate — the benchmark lending rate to which all loans are linked — may deplete lenders’ margins. Especially those of public sector lenders, which had aggressively raised deposit rates only last month and which they have to service for at least a year.

Banks that have cut their base rate after RBI’s move have also reduced deposit rates. However, the benefit of the latter cut would come with a lag; the effect of a loan rate cut would be felt immediately. It is difficult for banks to bring down deposit rates sharply when competing assets, such as small savings offer similar rates.

Following RBI’s repo rate cut on Tuesday by 50 basis points, Punjab National Bank, ICICI Bank, IDBI Bank and Bank of Maharashtra have reduced their base rates. Today, government-owned Bank of Baroda and Syndicate Bank responded with a 25 bps cut in their base rates to 10.5 per cent and a 25-50-bps cut in deposit rates.

Individual impacts
“Margins will be under pressure but may not hurt that much. It will depend on the liability profile of individual banks,” said M D Mallya, chairman and managing director, Bank of Baroda. Its own net interest margins from domestic operations were 3.3 per cent for the past few quarters and the bank expects it to stay above three per cent.

Investors have noticed that margin pressures weigh on public sector banks (PSBs), with share prices of those that had cut their rates declining more than the broader indices. Saday Sinha, deputy vice-president of Kotak Securities, said: “The NIM (net interest margin) of banks should compress with the cut in both lending as well as deposit rates, as lending rate cuts will start impacting the yield on assets, while deposit re-pricing comes with a lag. However, the decline in NIM will be arrested by the recent cut in CRR (Cash Reserve Ratio), along with the easing of bulk rates.”

Bankers said the positive effect of the 125-bps CRR cut in January-February was neutralised by the steep deposit rate increase, especially on bulk deposits, by banks in March. Due to that month’s mad rush for deposits (mostly by PSBs, which control two-thirds of the market), short-term rates went through the roof. Those on three-month certificates of deposit were up to 11.75 per cent, 100-150 bps higher than the rate a month before.

Some brokerages are preferring private banks over PSBs, as they perceive the former better poised to protect margins. “We continue to remain overweight on private sector banks, and retain Axis Bank and YES Bank as our top picks,” said an ICICI Securities’ note after RBI’s monetary policy action.

State Bank of India (SBI), the country’s largest lender, is yet to decide on reducing the base rate. It is, though, likely to reduce the spreads on automobile loans and on credit to small and medium enterprises. SBI increased both corporate and retail deposit rates by 50-100 bps after a hawkish RBI statement during the March mid-quarter review. SBI sources had indicated it might take a month or two before the cost of funds came down enough for it to reduce the base rate. Following SBI, some others also increased deposit rates, to remain competitive.

“The sentiment in March changed following a very hawkish statement from RBI in the mid-quarter review,” said a PSB chairman. “The expectation of a rate reversal changed and banks were not expecting any immediate change in policy stance. The mood was reflected in the bond market, as yields on the benchmark 10-year paper hardened significantly. But the more-than- expected rate cut by RBI now has changed the calculation all over.”