Protecting net interest margin poses a big challenge before banks

With increase in repo rate, banks had to offer better rates to depositors and some banks had long term deposit offering 7 to 7.50 and even 8%. There has been surge in demand for credit and credit of scheduled commercial banks grown at 15 to 17% whereas deposit growth has been lagging at 9%

The Reserve Bank of India may have taken a pause in the sustained repo rate hike it carried out since May 2022, but the commercial banks, caught between a strong credit offtake and a sluggish deposit growth, are left battling trying to protect their net interest margin (NIM).

The NIM reveals the amount of money that a bank is earning in interest on loans compared to the amount it is paying in interest on deposits. Indian banks' net interest margin (NIM) will face pressure in the financial year ending March 2024 (FY24) as they increase deposit rates to attract funds to support sustained high loan growth, says Fitch Ratings. However, it will remain well above the average level it saw between FY17 and FY22.

As the earnings season has kick-started with financial result of lenders like Bank of India and Union Bank of India already out and SBI to declare its financial result shortly, banks are expected to put out another quarter of strong numbers propped by loan growth and healthy asset quality. But the focus will be on NIMs and their management outlook, factoring in deposits’ mobilisation. The asset liability match (ALM), by slow deposit growth as against an aggressive credit climb, has been building pressure on the banks’ NIMs.

The Union Bank has registered NIM at 2.75 per cent in the fourth quarter of FY23. However, it has started making efforts to improve it to 3 per cent in the current fiscal.

Talking to Bizz Buzz, M Narendra, former CMD, IOB, said, “During Covid-19 RBI had to release more than Rs 12 lakhs of liquidity and also reduced repo rate 4 per cent even though inflation was higher so as to give boost to growth of Indian economy. This resulted in depositors getting negative interest rate. It is only since May 2022, RBI started increasing repo rate and there was increase of more than 250 basis point increase in repo rate and RBI paused repo rate increase in April 06, monetary policy and current repo rate stood at 6.50 per cent.”

With increase in repo rate, banks had to offer better rates to depositors and some banks had long term deposit offering 7 to 7.50 and even 8 per cent. There has been surge in demand for credit and credit of scheduled commercial banks grown at 15 to 17 per cent whereas deposit growth has been lagging at 9 per cent. RBI has also been following a policy of withdrawal of accommodation so the surplus liquidity has dried up, he said.

According to Narendra, “It is in this background banks have to offer attractive term deposits as less investors have option to invest in equity, physically assets like gold, property and other government savings schemes. Recently government has further increased the savings schemes (in some schemes by 70 bps) thereby making further attractive.”

These two factors both from depositor point of view expecting better returns and borrowers expecting lower borrowing cost with the better rating, the challenge on margin front will remain. Similarly in the increase in market interest rates, savers in savings deposit accounts also look at placement of term deposit which will enhance cost of deposits with reduced CASA.

So far, the banks have been able to pass on some part of the repo rate hikes to home loans that (as of end-December) comprise is whether the banks can continue to do so, especially at a time they are hopeful of expanding their loan portfolio.

In order to keep EMIs intact, the banks have already stretched the tenure of home loans. Their ability to travel further down this road, to keep the NIM at around 3 per cent, is limited. So now the banks are faced with waging a multi-pronged war to keep the NIM at the required level.

Provisional numbers released by some banks show remarkable credit growth with most lenders reporting double-digit numbers. On the other hand, deposit growth continues to lag, with the share of the low-cost current account, savings account (CASA) deposits showing another quarter of contraction. That is worrying for banks already seeing pressure on NIMs.

Shiva Kumar, former MD of State Bank of Bikaner and Jaipur, said, “Apart from deposit growth lagging credit expansion, RBI repo rate seems to have peaked. Any reduction in this rate now will lead to simultaneous transmission to the interest rates on loans.” But the deposits will take time to be repriced, awaiting their maturities. This will put pressure on NIMs, he said.

In the same period of May-February, the weighted average lending rate on fresh loans rose by 173 basis points. As discussed earlier, it is pertinent to note that full transmission of the rake hike to home loans disbursed since October 2019 (priced on external benchmark-based lending rates) helped banks offset the impact on NIMs.

While headline loan growth numbers may moderate because of a high base, demand is strong. Bankers remain upbeat on loan demand during the second and third quarters of 2023-24 across the major categories of borrowers, according to RBI’s quarterly bank lending survey.

RBI leaving the repo rate unchanged at 6.50 per cent, in its latest Monetary Policy Committee meet, means the loans, priced to external benchmarks (read repo rate), will also remain unchanged. Then again, though the apex bank has shared a hawkish outlook on future repo rate hike, lenders will have to tread cautiously on adding to the rising costs to borrowers and impairing their ability to repay.

As such, in February, the spread of the weighted average lending rate (on fresh housing loans) over the repo rate was 2.34 per cent compared to 2.63 per cent in September. This was done to ensure that borrowers can service loans on time and are not burdened.

One silver lining to the deposit rate hike is that it will automatically lead to an increase in the marginal cost of fund-based lending rate (MCLR). One-year and six-month, MCLR is currently used to price corporate loans. Over 46 per cent of floating rate loans are currently linked to MCLR, cushioning some impact on the NIM.

Banks are also focussing on high-yielding unsecured loans such as personal loans and credit cards to offset the impact. The confidence of lenders to underwrite such risky but margin-accretive loans rests on improved data availability, better-than-expected behaviour of borrowers during the pandemic and the low share of such loans in their books. They, of course, continue focusing on CASA deposits.

“Savings deposit rates of banks – which are a third of total deposits – have, however, remained almost unchanged in the current tightening period. This has moderated the increase in banks’ overall cost of funds and helped in improving their net interest margins,” the RBI said in the recently released monetary policy report. But winning the NIM game in FY24 will not be easy.