Interest rate margins may remain under pressure in the first half of the current financial year, as lenders continue raising funds at high costs to match soaring loan growth. In the March quarter, margins for most banks, especially the mid-sized lenders, were flat to slightly lower.
Margins compress when banks cut loan rates in line with benchmarks, but continue paying deposit interest at assured rates until they mature. Raising rates as deposits mature could help ease some of the margin pressure, but the banks are also constrained by their need to raise deposits to support loan growth.
Loan mix and rate dynamics
According to Fitch Ratings, an increased share of loans to retail, agriculture and MSME customers may help margins, as these loans are priced higher. However, this will be partly offset by a gradual shift towards secured loans which are given out at lower rates as well as lower treasury gains, the ratings company said in a note on 22 April.
“There could also be moderate downside risks if liquidity is tighter than we expect due to the RBI’s efforts to contain rupee volatility,” it said. ICICI Bank, Axis Bank and Bank of Maharashtra which focus on higher-yielding segments and keep funding costs in check will enjoy higher margins, Fitch added.
At India's largest private sector banks HDFC Bank and ICICI Bank, margins were 8-9 bps lower annually, but were up 2-3 bps on the quarter. The prime reason: Accelerated reduction in lending rates while deposit costs remained elevated. Both banks have said that while the outlook on margins is uncertain, they are likely to be "range-bound".
Between February and December 2025 last year, the Reserve Bank of India cut the repo rate by a total of 125 bps. Banks in India bring down interest rates in line with benchmark rates such as the repo, driving an industry-wide reduction in loan rates, even as deposit rates are raised only for fresh deposits and renewals, which comes with a lag. The higher transmission in lending rates is reflected in the fact that banks’ average outstanding loan rates fell to 8.99% in March, down 7 bps on quarter and 78 bps on year. In comparison, average rates on outstanding deposits declined to 6.62%, 6 bps lower on quarter and 49 bps lower on year, as per latest RBI data.
Deposit costs and competitive pressures
"NIMs will get supported by a rise in the share of personal loans which have been growing well. But the risk is from elevated competition for deposits and deposit rate hike. Some institutions have hiked rates on term deposits even in April. So, there is going to be a pressure on the deposit rates. Accordingly, there are a lot of these moving parts, which give some kind of lack of clarity on margins. But there is more downward side pressure," said Anil Gupta, senior vice president and co-group head - financial sector ratings at ICRA.
The central bank expects the policy rate to remain “low for long”, indicating lower lending rates for banks amid high cost of funds.
While loan growth was robust during the second half of FY26, it was largely led by lower-yielding secured retail, SME and corporate loans, whereas higher yielding loans such as credit cards saw a slowdown. The need to mobilize deposits to match this pace of loan growth, especially in lower yielding segments, could ensure that margins remain under pressure, experts said.
Limited relief ahead
“Given the low return on assets (RoA) that most PSU banks operate on, the acute and chronic credit cost impacts weigh heavy on earnings growth prospects as well as on residual RoA and therefore on incremental competitiveness (especially in lower margin prime categories),” Santanu Chakrabarti, analyst – banking and finance, BNP Paribas said in a note dated 29 April. The top three private banks – HDFC, ICICI and Axis are the brokerage firm’s top choices.
As part of its earnings guidance, Federal Bank said that amid high competition, it is going slower on home loans – where some PSU banks are giving loans starting as low as 7.1% -- in order to protect margins.
To be fair, banks have been reducing reliance on bulk and high-cost savings and term deposits, reflected in the increase in share of low cost current account and savings account (CASA) deposits for most banks in Q4.
As a result, these banks did benefit from the reduction in deposit rates during Q3 and Q4, leading to the sequential improvement or stability in margins. However, with deposit repricing now having largely played out, lenders fear that margins could come under pressure given the limited room for future reduction in deposit rates.
Indian Bank said that the “sticky cost of funds” and accelerated loan growth is expected to lead to further compression in margins. “If credit growth is strong, bulk (deposits) we are getting at a higher rate, so then there is no point in cutting rates on retail term deposits,” managing director and chief executive officer Binod Kumar told Mint. The bank’s net interest margin (NIM) could compress to 3.15-3.25% in FY27 from 3.24% in FY26, he added.
Kotak Mahindra Bank, in its Q4 earnings on Saturday, posted a decline in margins for the year. The bank said that while the pace of margin compression could ease, margins will continue to decline in FY27.
“Going forward, we expect a more gradual decline in margin,” chief financial officer Devang Gheewalla said in the bank’s Q4 earnings conference, adding that the movement is likely to not be as sharp as FY26.The private sector lender hiked rates on 2-3 years fixed deposits by 10 bps in the last week of April.