Indian banks’ margins have peaked and are set to shrink now

It is the profit that banks make from the interest they earn on loans minus the interest they pay on deposits. It indicates how well banks can generate income from their lending activities compared to the cost of acquiring funds.

The expectation of NIM compression is in contrast to fiscal 2023, which is estimated to have seen an expansion of  around 30 bps to 3.2 percent from 2.9 percent in fiscal 2022.

On the assets side, with nearly 80 percent of advances being on floating interest rates , banks' interest income rose sharply as repo rates started rising. On the liabilities side, deposits are predominantly at a fixed cost, resulting in any higher interest rate being applicable only to the incremental deposits raised and renewals.

Banks chose to raise deposit rates well after lending rates rose even though the pace of deposit growth was slower than credit growth last fiscal, opting instead to utilise their excess liquidity, the CRISIL study said.

Additionally,  the present repo rate pause would limit banks' ability to further increase lending rates on loans linked to external benchmarks.

Of course, the second-order effect of a rise in cost of funds on MCLR (marginal cost of funds based lending rate) would, in turn, have a benefit on the assets side with somewhat higher lending rates. But the extent of that will be relatively less.

"We believe NIMs for the banking sector have peaked. Competition for deposits has driven banks to hike rates since October 2022, and they could increase further given that deposit growth continues to lag credit growth. With an estimated 30- 35 percent of deposits expected to come up for re-pricing this fiscal, at higher rates, and the shift from current and savings deposits to term deposits continuing, overall deposit costs will rise this fiscal. And given that most of the re-pricing on the assets side has already been done, the NIM gains seen last fiscal will partly reverse," Krishnan Sitaraman, Senior Director and Chief Ratings Officer, CRISIL Ratings said.

Earlier in February, Fitch Ratings had also highlighted that banks may see a downward pressure on NIMs in this fiscal.

"We expect the Indian banking sector's average NIM to slightly contract by about 10bp in FY24 to 3.45 percent, following a 15bp increase in FY23 to 3.55 percent, under our base case, but remain well above that in prior years (FY17-FY22 average: 3.1 percent). This contraction is consistent with the lagged normalisation in deposit rates, although banks should be able to offset some of the impact as they gradually pass-through policy rate hikes to corporate loans, which are typically slower to reprice than retail and SME loans," Fitch had said in a February report.

While NIMs are expected to compress this fiscal, a reduction in credit costs will provide an offset and support overall bank profitability, CRISIL said .

Gross nonperforming assets (GNPAs) have already hit a decadal low of 3.9 percent as on March 2023, and leading indicators such as the quality of the corporate loan portfolio point to a further reduction in GNPAs this fiscal.

"Provisioning coverage ratio is at an all-time high of 75 percent for the banking system. Therefore, credit costs, which had started to correct in fiscal 2021 from 1.8 percent on average between fiscals 2016 and 2020, are estimated to have dropped to 0.7 percent in fiscal 2023, and are expected to fall further this fiscal," Subha Sri Narayanan, Director, CRISIL Ratings said.