Higher deposit pricing to weigh on banks’ earnings

Banks are expected to see a 10-20 bps compression in their net interest margins (NIMs) to 3-3.1 per cent this fiscal as they price deposits higher to attract more funds, says a report. However, lower credit costs will offset this tailwind on account of continued benign asset quality, which will help them maintain profitability steady after touching a decadal high of 1.1 per cent on a return on assets basis, last fiscal, Crisil Ratings said in a report on Tuesday.

According to Krishnan Sitaraman, a senior director and chief ratings officer at the agency, NIMs have peaked at the system level. Competition for deposits has driven banks to hike rates since October 2022, and they can increase the rates further given that deposit growth continues to lag credit growth. With an estimated 30-35 per cent 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 and get compressed by 10-20 bps to 3-3.1 per cent, he added.

The expectation of NIM compression is in contrast to fiscal 2023, which is estimated to have seen an expansion of 30 bps to 3.2 per cent from 2.9 per cent in fiscal 2022, due to the differential pace of rate changes between the assets side and the liabilities side for most of fiscal 2023. On the assets side, he said with around 80 per cent of advances being on floating interest rates, interest income rose sharply in FY23 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, he said. 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. Additionally, the Reserve Bank has now hit pause on repo rate hike for the time being, which would limit the ability of banks 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 would, in turn, have a benefit on the assets side with somewhat higher lending rates. But the extent of that will be relatively less, said Sitaraman.

According to Subha Sri Narayanan, a director at the agency, while NIMs are expected to compress this fiscal, what will provide an offset and support overall profitability is a reduction in credit costs. Gross NPAs have already hit a decadal low of 3.9 per cent in FY23, and leading indicators such as the quality of the corporate loan portfolio point to a further reduction in GNPAs this fiscal. Further, the provisioning coverage ratio is at an all-time high of 75 per cent at the system level. Therefore, credit costs, which had started to correct in fiscal 2021 from 1.8 per cent on average between fiscals 2016 and 2020, are estimated to have dropped to 0.7 per cent in fiscal 2023, and are expected to fall further this fiscal, he said without ascribing a number to it.

In addition, the drag on non-interest income from treasury losses in the initial part of fiscal 2023 is unlikely to repeat this fiscal as almost three-fourths of their bond holding are in the held-to-maturity mode, given that rates are not expected to rise materially from here. Hence, while NIMs will shrink this fiscal, overall profitability will remain at 1.1 per cent after having continuously improved for the past three fiscals, he said.