With the Reserve Bank of India (RBI) shifting the stance to neutral. expectations are building for a rate cut cycle from December policy.
Most leading economists with financial institutions and rating agencies believe that a rate cut is very close and will begin from December itself. They see rate cuts of 25 bps to 75 bps by the central bank this fiscal.
But while borrowers will be happy, how would the rate cuts play out for banks?
Aditi Nayar, Chief Economist and Head of Research and Outreach, ICRA Ltd said, “This has opened the door for a potential rate cut in December 2024, if the lurking risks to inflation, both domestic and global, do not materialise. In our view, the Indian rate cut cycle will be fairly shallow, restricted to 50 bps over two policy reviews.”
A potential 50 basis point (bp) repo rate cut could negatively impact the net interest margins (NIMs) and return on assets (RoA) of many large Indian banks, according to a recent analysis by Nomura. Large private sector banks, including ICICI Bank, Axis Bank, and HDFC Bank, could see their NIMs decline by 15-20bp, with RoA dipping by 5-10bp. This is because around 50-60% of their loan portfolios are directly tied to the repo rate or other external benchmarks. Meanwhile, mid-sized and smaller banks like IndusInd Bank, AU Small Finance Bank, and Bandhan Bank, which have a higher proportion of fixed-rate loans, are expected to face smaller NIM impacts, around 12bp.”Banks have 30-60% of their loan books linked to the repo rate or external benchmarks, while their liabilities remain largely on fixed rates, repricing lower only at maturity. This structure leaves them exposed to potential rate cuts,” the Nomura report noted.
Smaller banks and PSU lenders to face limited impact
While larger private banks are more vulnerable due to their loan portfolio structures, public sector banks such as State Bank of India (SBI) and Bank of Baroda (BoB), which have more MCLR-linked loans, are expected to experience a relatively smaller NIM erosion of around 12bp. Additionally, banks with a significant proportion of fixed-rate loans, like IndusInd Bank, AU Small Finance Bank, and Bandhan Bank, are expected to see negligible impacts on their RoA. Treasury gains from their marked-to-market (MTM) portfolios could also help offset some of the pressure.
EPS decline and treasury gains
The potential repo rate cut could lead to a 2-8% decline in earnings per share (EPS) for large private banks in FY26, with return on equity (RoE) falling by 10-110bp. Public sector banks, such as SBI and BoB, are likely to see a smaller hit to their RoA but could experience a 6% drop in EPS due to their lower profitability compared to private banks. However, treasury gains from available-for-sale (AFS) and held-for-trading (HFT) portfolios could help mitigate some of the profitability losses.
CASA and deposit growth
Despite the downward pressure on NIMs, deposit growth and current account savings account (CASA) ratios are expected to improve under a more accommodative monetary policy. Historically, CASA ratios tend to rise during periods of rate cuts, softening the blow of shrinking NIMs. Nomura’s analysis indicates that every 1% rise in the CASA ratio could enhance NIMs by 4-5bp.
CRR cut offset by new LCR norms
While a potential 50bp cut in the Cash Reserve Ratio (CRR) could provide banks with a 3-5bp lift to their NIMs, this benefit may be negated by the tighter draft liquidity coverage ratio (LCR) norms, which are scheduled for implementation by April 2025.
“Our prognosis is of benign margin expansion or, at the very least, stability in FY26 after a shallow bottom in late FY25 for large banks (‘Rate cuts – a belated gentle tailwind’). Hence, strong credit growth should drive concurrent earnings growth momentum in FY26 – a key re-rating catalyst in our view,” said a BNP Paribas note after the RBI policy on October 9.
