Liquidity easing to moderate pressure on banks' net interest margins: Fitch

Global rating agency Fitch Ratings has said that steps initiated to ease liquidity conditions will help moderate the pressure on Indian banks' net interest margins (NIM) from policy interest rate cuts.

 

Indian bank NIMs are expected to decline by about 10 basis points on average in the financial year ending March 2026 (FY26). The impact ranges between 5 basis points and 15 basis points for Fitch-rated banks, the agency said in a statement. The Indian banking sector’s NIM remains healthy at 3.5 per cent as of the first half of FY25, although it has declined from about 3.6 per cent in FY24, partly due to the upward repricing of deposits under tighter liquidity conditions during 2024.

 

The agency said system liquidity pressures have moderated since late January 2025, partly due to Reserve Bank of India (RBI) actions, including durable liquidity injections through open market operations and other short-term liquidity measures. However, this has so far been insufficient for banks to lower their deposit costs.

 

High recoveries from written-off loans and lower operating costs due to increasing digitisation may mitigate some of the NIM impact as policy rates ease. “We anticipate that banks might also get some near-term support from delays in implementing higher deposit run-off rates and expected credit losses until after FY26,” Fitch added.

 

The immediate effect of a rate cut will be felt on floating loans linked to external benchmarks, such as housing and micro, small and medium enterprise (MSME) loans, but it will also be reflected in fresh loans in a declining policy rate environment.

 

The RBI’s latest repo rate reduction—by 25 basis points to 6.25 per cent—was in line with the agency’s assumptions. However, Fitch does not expect this to drive changes in the credit profiles of rated banks. The agency expects an additional 25 basis points repo rate cut in FY26.

 

“We believe the sector’s NIM will trend towards the long-term average of about 3 per cent, amid slower loan growth and lower yields,” Fitch said.

 

If banks remain unable to bring deposit costs down in line with falling policy rates due to tight liquidity, their NIMs could narrow faster than expected. This is not Fitch’s base case, but as the liquidity situation evolves—alongside any further policy rate cuts—its impact on banks’ NIMs and overall profitability will be a key factor to watch.

 

Fitch does not expect pressure on Earnings and Profitability scores for Fitch-rated banks due to rate cuts under its base case. Overall operating profit to risk-weighted assets (OP/RWA) is set to decline for most banks in the near term, but the agency’s scoring incorporates some headroom, as its assessments consider metrics throughout the cycle.