The pandemic is making it harder for Indian banks to hold on to margins

Interest rates in India have been on a downward trajectory for more than 18 months. The quibble about transmission of policy rate cuts onto lending rates seems to have been resolved to some extent now. Thus, while India’s lenders have been able to protect net interest margins in the past, these are poised to moderate in FY21. Net interest margin is a measure of the difference between the interest income generated and paid out.

Several signs are visible. Retail and small business loans have already been linked to the policy repo rate and progressively the yield on this portfolio is expected to come down for banks. These loans account for a small portion of the total, but given a recession this year, policy rate cuts are far from over and the downward pressure on these loans will not abate.

The marginal cost of funds based lending rate (MCLR) of banks, too, has been coming down fast. The weighted average lending rate has dropped 72 basis points (bps) from levels seen before the pandemic. A basis point is a hundredth of a percentage point.

Another factor is the huge pile of bad loans that banks carry. Banks are far from getting a quick resolution on these dud loans. The pile is only going to increase in the current year, as the lockdown has hit the cash flows of not just businesses, but also households. The trend in moratorium is uncertain, though most banks had at least a quarter of their loan book under moratorium as of May.

When banks cannot collect the interest owed to them on a regular basis, it has a bearing on margins. “Further downward pressure in the medium term could come from interest reversals on NPLs. Overall, we expect a flattish to marginal decline in NIM for most banks,” analysts at Kotak Institutional Equities wrote in a note.

In addition, the provisions towards covid-19 risks are also an additional pressure. In such times, new loans that fetch interest income are hard to come by.

Bad loans and falling interest rates are not new and the pandemic has only added to their severity. What could be a trigger for margin moderation is the deceleration in high-yield unsecured loans. Analysts at Kotak point out that most banks are going slow on their unsecured loan portfolio. These include personal loans towards consumption, perhaps the segment most affected by the lockdown.

As such, banks prefer to conserve capital owing to the pandemic. However, there are offsetting factors as well. Moderation in deposit rates is one. The weighted average term deposit rate has already dropped by 26 bps in the first two months of FY21.

Recoveries from bad loans could also contribute to this, though this hinges on quick resolutions.