For private sector lenders, the pressure on net interest margins (NIMs) is likely to ease. Data for system-wide average lending and deposit rates published by the Reserve Bank of India (RBI) indicates that NIM compression is arrested and that margins could gradually improve, according to Kotak Institutional Equities.

“The gap between weighted average lending rates and fresh lending rates has declined from peak values of around 85-95 basis points (bps) in the December quarter of fiscal year 2019 to nearly 60 bps," it said in a report on 25 February.

One basis point is one-hundredth of a percentage point.

A look at the average outstanding and fresh lending rates for all scheduled commercial banks between December 2016 and December 2018.
A look at the average outstanding and fresh lending rates for all scheduled commercial banks between December 2016 and December 2018. (Naveen Kumar Saini/Mint)

Lending rates started climbing since January 2018 and hit a peak when the liquidity crisis broke out at non-banking financial companies (NBFCs) in November last year.

Over the last few quarters, banks have revised their marginal cost of funds-based lending rates higher. The impact of this comes with a lag and is seen on incremental loans, driving the wedge between historical average and fresh ones lower. Term deposit rates have remained stable. Margins are basically the difference between a bank’s borrowing cost and lending cost. So, on the one hand, deposit rates have remained flat and, on the other, lending rates are improving, boosting prospects for margin improvement.

“With gradual revival in lending from PSU banks (three banks have exited the Prompt Corrective Action framework) and a flat loan growth at 15%, private banks will gradually soften growth trends leading to reduction in credit deposit ratio (operate at >90% CD ratio). This will reduce pressure on private banks to borrow at higher rates as passing the benefit was challenging," said the Kotak report.

Lower slippages and interest recoveries are also expected to aid margins.

That said, the scope for improvement in NIMs is limited and its sustainability is debatable. Private sector banks saw some pricing power because of weakness in NBFCs. However, NBFCs are expected to make a comeback and that could bring back the threat on margins. 

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