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Indian banks’ net interest margin (NIM) will be under pressure in the next financial year ending March 2024 (FY24) as they increase deposit rates to get funds for supporting high loan growth, said Fitch Ratings on Monday.
The Indian banking sector’s average NIM– an indicator of profitability–is expected to contract by about 10 basis points (bps) in FY24 to 3.45 per cent. This follows a 15 bp increase in FY23 to 3.55 per cent, but remains above that in prior years (FY17-FY22 average: 3.1 per cent), said Fitch.
This contraction was consistent with the lagged normalisation in deposit rates. Banks should be able to offset some of the impact as they gradually pass on policy rate hikes to corporate loans, which are typically slower to re-price than retail and SME loans, said the rating agency in a statement.
The 10 bp reduction in NIM is unlikely to affect banks’ profitability in the near term. Higher fee income from loan growth and a revival in treasury gains should broadly counterbalance the twin pressures of higher credit and funding costs in FY24, while supporting capitalisation.
However, loan growth outstripping deposit growth—as seen in the past few months—is a potential risk. NIMs could face greater pressures if banks are forced to increase deposit rates further and turn to wholesale funding, for which costs are rising. “The risks could be potentially pronounced if higher interest rates are unable to meaningfully moderate credit demand and increase deposit inflows as we expect under our base case,” Fitch said.
The sector’s average loan growth reached 17.5 per cent in the first half of FY23, with the trend continuing in December 2022 as per latest central bank data, compared with Fitch’s full-year estimate of 13 per cent for FY23. This is partly driven by pent-up credit demand and normalisation of excess savings built up during the pandemic.
Corporate borrowers migrating from local bond markets to banks due to hardening in yields has pushed credit expansion. Banks will likely enjoy some pricing flexibility due to this shift, but competition among them for market share will eventually limit their ability to pass on the increase in funding costs to borrowers.
The expansion in banks’ NIM in recent years—to 3.5 per cent in April-September 2022 ( first half of FY23) from 2.9 per cent in FY19, by Fitch’s estimates—was due to a decline in funding costs. This was driven by a sustained period of low credit demand and high liquidity, rather than higher loan pricing.
The sector’s increased focus on higher-yielding segments, like unsecured personal loans, credit cards and consumer durable loans, may have helped somewhat. But, there was steady increase in the sector’s loan-to-deposit ratio to 75 per cent by the end-December 2022, from 71 per cent at FYE22. It led to an accelerated transmission of the central bank’s 225bp rate hikes in 2022 to deposit rates since 1HFY23, thus pushing up banks’ cost of funds.
Moreover, with a significant share of banks’ loan books in safer but lower-yielding segments, such as housing loans, project financing especially roads, non-banks and guaranteed credit to small businesses, passing through increases in funding costs would be progressively challenging despite floating interest rates on 93 per cent of loans at FY22.
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