Rising cost of funds may squeeze bank interest margins by 30 bps more

Banks are likely to see their net interest margins (NIM) — broadly the difference between interest earned on loans and paid on deposits — shrink by another 30 basis points (bps) over the next few quarters.

After hitting a peak of 3.3 per cent in the third quarter (Q3) of the financial year ended March 31, 2023 (FY23), NIMs have been on a downward trajectory, touching 3.13 per cent in Q2FY24 on higher cost of funds, according to capital markets firm CARE Ratings.

Banks are still grappling with the Reserve Bank of India’s policy rate increases — that have made deposits costlier as the interest payable to customers has increased — and the regulatory actions on unsecured lending.

The NIMs are expected to further moderate in coming quarters and are estimated to retreat to pre-rate hike cycle levels seen around Q2FY22, the rating agency said.

The RBI began raising policy repo rate in May 2022 from around 4.0 per cent and it currently stands at 6.5 per cent.

NIMs of banks stood at 2.83 per cent in Q2FY22.

Public and private sector banks reported NIMs of 2.45 per cent and 3.59 per cent, respectively, in the quarter.

In terms of sequential performance, margins of scheduled commercial banks (SCBs) declined 14 bps to 3.13 per cent and, private and public sector banks recorded a decline of 27 bps and 10 bps, respectively.

The margin moderation is expected to continue as the cost of deposits is anticipated to remain elevated, CARE Ratings said.

According to the RBI’s latest data, the weighted average interest rate on domestic term deposits has risen to 6.76 per cent in October 2023 from 6.47 per cent in June 2023 and 5.62 per cent in November 2022.

The rising interest rates have pushed the cost of deposits.

For public sector banks, cost of deposits, which refers to the rate of interest the bank pays on deposits, rose to 4.93 per cent in Q2FY24, from 4.68 per cent in Q1FY24 and 3.93 per cent in Q2FY23.

For private banks, the rise in cost of deposits has been much sharper at 5.73 per cent in Q2FY24 from 4.99 per cent in Q1FY24 and 4.13 per cent in Q2FY22.

The rising yield due to repricing of loans and fresh credit disbursal at higher rate helped boost NIMs.

The yields on PSB advances rose to 8.59 per cent in Q2FY24 from 8.48 per cent in Q1FY24 and 7.44 per cent in Q2FY23.

For private sector lenders, yield on loans rose to 10.7 per cent in Q2FY24, up from 10.08 per cent in Q1FY24, and 9.06 per cent in Q2FY23, rating agency analysis showed.

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