Banks' net interest margins likely to decline further after RBI rate cut

Extent of NIM compression will depend on further rate cuts

The 25-basis-point (bps) cut by the six-member Monetary Policy Committee (MPC) last week is expected to further compress net interest margins (NIMs) of banks. The banks were already under pressure due to the elevated cost of deposits because of tight liquidity conditions.

 

Margins are under pressure also due to recalibration in the unsecured retail segment, which typically yields higher margins for banks.

 

"The 25-bps cut was expected. This would be slightly negative on the NIMs as the deposit cost will not come down but the lending rates will fall immediately on the external benchmarked linked loans (EBLR). Having said that, some liquidity measures, including a cash reserve ratio (CRR) cut, would have helped,” said a senior private sector banker.

 

The external benchmarked linked loans will get repriced immediately to reflect the rate cut. The deposit rates will take time to reflect the same. Only the new deposits that will be acquired will be at the revised rates but given the tight market, it is unlikely that banks will reduce their deposit rates so soon.

 

According to Swaminathan J, deputy governor, RBI, the EBLR-linked loan book is about 40 per cent, on which the rate cut impact will be more immediate. 

 

For monetary policy transmission to the deposit rates, it again takes about two quarters, he added.

 

“We foresee NIMs and return on assets (RoA) declining next fiscal. That is because a rising proportion of floating rate loans is benchmarked to external rates — over 40 per cent of the total loan book — which are expected to move in tandem with the repo rate. Consequently, the assets side will see a quicker downward repricing, compared with the liabilities side. The extent of NIM and RoA compression will depend on further rate cuts”, said Ajit Velonie, Senior Director, Crisil Ratings.

 

He also highlighted that  the cost of funds for banks is sticky given the competition for deposits. Therefore, banks may price this in through a wider spread over the benchmark rate.

 

In both Q1 and Q2, banks faced pressure on NIMs due to the high cost of deposits and slow growth in unsecured retail segments, including personal loans, credit cards, and microfinance, which experienced elevated stress, and are typically higher margin-yielding products for banks.

 

“We believe, with unsecured loans expected to pick up and possibly a shallow rate cut cycle and delayed liquidity coverage ratio (LCR) norms, margins could compress by 10-15 bps. The critical factor is how much loan growth and deposit growth recovers from the current 11 per cent levels”, said Suresh Ganapathy, managing director, Macquarie Capital.