The Music Is Slowing At The NIM Party For Banks

The high net interest margin party seems to be ending for the Indian banking system as more deposits get repriced. An overview of the Q1 earnings posted so far indicates a pattern that margin has fallen sequentially in the quarter ended June.

Among lenders who saw sequential compression on margin include ICICI Bank Ltd. (12 basis points), Federal Bank Ltd. (16 bps), Kotak Mahindra Bank Ltd. (18 bps) and Yes Bank Ltd. (30 bps).

While HDFC Bank Ltd.'s margin stayed flat at 4.3%, lenders like IDBI Bank Ltd. and Union Bank of India reported an increase.

In the case of IDBI Bank, the rise in margin was partly due to a one-time benefit from a Rs 1,000 crore loan recovery reported during the first quarter. According to Rakesh Sharma, managing director and chief executive officer of IDBI Bank, the NIM continues to remain high at 3.94%, even if the lender was to exclude the one-time recovery.

The bank has guided that NIMs will remain at above 3.5% during the year.

A bank’s NIM is a key profitability indicator, which is reflected by the difference between a bank’s earning from interest rates on loans and the interest it pays on deposits.

In FY23, scheduled commercial banks sustained the momentum in profitability as their NIM continued to grow, according to RBI’s Financial Stability Report released on June 28.

“During 2022-23, the NIM improved by 30 bps as transmission of monetary policy tightening to deposit rates lagged the pass-through to lending rates,” it said.

Between May 2022 and April 2023, the Monetary Policy Committee hiked the repo rate by 250 bps.

In light of the consistent rise in interest rates, all floating rate loans were repriced according to the new rates. The cost of funds was low and hence, the banks were able to maintain strong NIMs, said Ajit Kabi, banking analyst at LKP Securities.

“Banks need to raise their deposits as well and this deposit competition is very high. So, to attract more customers, they have to raise their deposit rates, which is eventually affecting the cost of borrowing of a bank. If the latter goes high, repricing would not be in tandem and the net interest margins will be impacted,” he said.

During FY23, the repricing on loan books happened at a much faster pace as compared with the deposits as banks were holding a higher proposition of variable loans. Because of this lag, Q1 FY24 saw a higher repricing in the deposit book adding to the pressure on banks' margins, said Cyril Charly, research analyst at Geojit Financial services.

“The deposit growth has now picked up and a large part of this is going towards fixed deposits. Hence, you would also see banks’ CASA ratios coming down. It shows that money is moving from low-cost CASA to high-cost fixed deposits,” Charly said.

Given the current economic landscape and increasing competition, analysts expect the pressure on banks’ NIM to continue in the near-term. In case banks are forced to increase deposit rates further and turn to wholesale funding for which costs are also rising, the NIMs would continue to face pressure, according to a Fitch Ratings’ report in February.

“We expect the NIMs to compress further in coming quarters as deposit competition is intensifying and yields have no major room for improvement. From H1 FY24, we may witness stability in NIMs as credit and deposits will be at equilibrium,” said Kabi.

The central bank’s upcoming MPC outcome in August would be something to look out for, especially from the point of view of banks’ NIMs, according to analysts.

“In terms of key monitorables, we will wait to see what RBI does and if it increases the rates further. We would also keep a watch at banks’ asset liability management to determine the health of margins,” said Kaitav Shah, research analyst at Anand Rathi Institutional Equities.