Banks eye margin recovery in H2 as rate cycle turns

The Reserve Bank of India’s 25-basis-point repo rate hike in October is expected to benefit banks with a higher proportion of floating-rate loans, as lending rates reprice upwards. At the same time, comfortable liquidity conditions could allow lenders to defer raising deposit rates, providing some support to spreads. The recovery would also be supported by a gradual shift towards higher-yielding retail and MSME loans, compared with corporate and home loans.

Around 20-30% of the bank’s retail loan book runs off annually, allowing fresh lending to gradually alter the portfolio mix. “Going forward, across the next two quarters, you will see that change coming through, as we also grow the volumes in retail and MSME,” Jagdishan said. The impact of the rate hike could become visible as early as the December quarter for some lenders. Surplus liquidity from FCNR(B) deposits is likely to keep deposit rate transmission muted for now.

Most lenders are expected to raise deposit rates only after the surplus is absorbed and competition for domestic deposits intensifies. Faster repricing of EBLR-linked loans will widen margins. As of June 30, EBLR-linked loans accounted for 68.2% of scheduled commercial banks’ outstanding floating-rate rupee loans, while marginal cost of funds-based lending rate (MCLR)-linked loans constituted 29.6%, according to RBI data.

Its domestic NIM had already improved to 2.74% in the September quarter from 2.64% in the preceding quarter. PNB Managing Director and Chief Executive Officer Ashok Chandra said the bank was comfortable with its deposit mobilisation and was not in a hurry to raise deposit rates. However, the benefit of higher lending yields may take longer to translate into an overall margin recovery for lenders that have seen significant changes in their funding and asset mix.

ICICI Bank expects the full impact of a sequential increase in retail term deposits and a higher share of overseas branch assets to be reflected in the December quarter, before margins begin recovering thereafter. The bank’s domestic NIM, excluding interest income on income-tax refunds, declined to 4.32% in Q2 from 4.36% in Q1, while its cost of deposits increased to 4.50% from 4.41%. ICICI Bank Group CFO Anindya Banerjee said margins were expected to start moving upwards after the third quarter, even at prevailing policy rates.

Similarly, RBL Bank expects margins to moderate further in Q3 before improving in Q4, with the pace of recovery dependent on its ability to deploy funds into higher-yielding advances rather than investments. “I would imagine that we should be slightly lower next quarter, and then, probably inch up in Q4,” Jaideep Iyer, executive director at RBL Bank, said in the post-earnings analyst call. The impact of FCNR-related business has also emerged as a drag on margins.

Axis Bank attributed 11 bps of its 37-basis-point year-on-year decline in NIM to FCNR-related business, while changes in the balance sheet mix accounted for another 16 bps. The remaining 10 bps reflected the lagged impact of earlier policy rate cuts, partly offset by liability repricing. Other lenders expect a steadier trajectory. Federal Bank continues to target an average quarterly improvement of 5-6 bps in margins during FY27, although Managing Director and Chief Executive Officer KVS Manian cautioned that the improvement would not be linear.

Canara Bank expects to sustain its NIM at around 2.55%, supported by the recent rate hike and retail credit growth. With 53% of its loan book linked to the repo rate, the eventual benefit will depend on the pace of repricing of both advances and deposits.