Banks' margins to fall by 10 bps in FY 26 due to rate cuts: Fitch

Last week, after nearly five years, the RBI began an easy money policy by lowering its key policy rate by 25 bps to 6.25%.

MUMBAI: Banks have been witnessing margin squeeze for a year now after being forced to offer better pricing for deposits as monies were going into other better-yielding assets like stocks and mutual funds. They will now see more pressure on their key profitability metric--the net interest margins (NIMs)—in FY26 due to the interest rate cuts by the Reserve Bank.

NIMs are on an average will fall by 10 bps but the drop will be cushioned by the central bank easing liquidity conditions, says a latest report by Fitch Ratings. While deposit repricing takes time, repo-linked loans also will have to be repriced following the RBI rate cut, the report added.

Last week, after nearly five years, the RBI began an easy money policy by lowering its key policy rate by 25 bps to 6.25% and said it will be watchful and proactive with liquidity measures, given the banking system has been in a liquidity deficit for the last two months.

"The immediate effect of the rate cut will be felt on floating loans linked to external (repo) benchmarks, such as housing and small business loans, but will also be felt through fresh loans in a declining policy rate environment. This will have an average of 10 bps fall in NIMs this fiscal," Fitch Ratings said on Thursday.

Even before the rate cut began, all banks reported lower margins in the December quarter, with the industry leader SBI reporting 19 bps loss in the quarter to 3.13% while the second largest lender HDFC Bank reported flat NIM at 3.43% on-year and 7 bps down from  Q2 when it was 3.5%.

Non-bank financial institutions may also see pressure on NIMs, which is the difference between interest earned from loans and paid on deposits-- in segments where they compete with banks, such as near-prime urban housing or commercial loans, the agency said.

The pass-through or transmission to loan rates should happen immediately—already seven banks such as PNB, BoB, Union Bank, Central Bank and Uco Bank have lowered their repo- linked loans. As much as 40% of all loans are linked to the repo rate therefore have to be lowered.

But, banks’ margins remained healthy at 3.5% from April to September 2024, Fitch said, noting this was a dip from about 3.6% in the previous fiscal partly due to the upward repricing of deposits as liquidity tightened.

"We believe NIMs will trend towards the long-term average of about 3% amid slower loan growth and lower yields," Fitch said, adding however, if tight liquidity prevents banks from lowering deposit costs in line with falling policy rates, their NIMs could narrow faster than expected.

The system level liquidity hit a one-year high of over Rs 3 trillion in January and was above Rs 2 trillion on Wednesday. Fitch said banks may get some near-term support from delays in implementing higher deposit run-off rates and expected credit losses until after 2025-26.