The falling interest rate regime has given banks a double-whammy in terms of net interest margin and return on assets, both of which are set to take a hit of 10-20 bps each this fiscal.
The interest rates on loans are likely to come down faster than those on deposits. Return on assets (RoA) of banks is set to fall 10-20 bps to 1.1-1.2% this fiscal from an over-two-decade peak of 1.3% in fiscals 2024 and 2025. Not just that, this will be driven by a similar contraction in their net interest margins (NIMs) to 2.8-2.9% this fiscal, Crisil Ratings said in a note.
The agency also expects another 50 bps cut in the repo rate this fiscal, taking the total rate cuts to 100 bps --- from 6.5% to 5.5%. Apart from NIMs, credit costs also have a bearing on banks’ earnings. The agency said while a secular decline in credit costs has supported profitability in the past a few years, they have bottomed out now. With other income and operating expenses, which are the other major components of earnings, are seen heading to flat growth, NIM compression will translate to a moderation in RoA after accounting for taxes
Nevertheless, overall profitability will remain above the 20-year sectoral average of 0.8%, which was 0.6% in the past decade. As per Subha Sri Narayanan, director at Crisil, of the loan assets, 45% are linked to an external benchmark (EBLR), the repo. These are repriced after rate cuts. On the other hand, any cut in term deposit rates (which constitute as much as 60-65% of system wide deposits) will apply to incremental deposits and renewals, resulting in a slower transmission/downward repricing of liabilities. Data shows only 21% of term deposits are maturing in a year, which means the rest will be due for repricing only after this fiscal.