Indian banks are likely to see a shrink in Net Interest Margin (NIM) over the next two years from its cyclical peak of 3.6 percent in the first nine months of FY24, Fitch Ratings said in a report on March 26.
The shrink in margin will be caused by higher funding costs triggered by heightened race for deposits, normalising liquidity conditions, and elevated loan growth, the rating agency said.
Fitch Ratings added that there is room for banks to lower their operating and credit costs to offset the impact, driven by cost control and increasing efficiency from digitalisation, and scope for impaired-loan ratios to fall further across most banks.
The ratings agency, however, stayed bullish on the profitability front and said that profits will improve, though NIM compression will limit the earnings upside over the medium term.
“Banks' rising funding cost is likely to remain an important factor driving NIMs, but we expect earnings to be resilient despite the sector's dependence on net interest income, which contributed 75 percent of the total operating income in the nine months of the financial year ending March 2024 (9MFY24),” Fitch said.
The Indian banks are likely to further reallocate their investments in government securities in excess of statutory reserve requirements towards loan growth, it added.
This will continue to offset the pressure on margins in the near term, but the banks' higher risk appetite would also drive up the risk density. The ongoing shift from investing to borrowing is reflected in the rising proportion of loans in the banking sector assets to about 63 percent in the nine months of FY24 from 56 percent in FY22.
The gap between loan growth and deposit growth will persist, implying that banks with greater share of low-cost deposits will have the advantage.
Fitch estimates that the share of low-cost deposits fell by about 490 basis points (bps) to around 39 percent of system deposits in 9MFY24, from FY22. This was driven by greater competition and the resultant rise in the cost of term deposits, which also spurred a shift from low-cost deposits to term deposits.
Most Fitch-rated banks comfortably exceed the system average in terms of low-cost deposit share, although some banks with high LDRs have had to partly rely on wholesale deposits, said the agency.
Fitch expects that funding would not be a significant challenge for the banks, given their reliance on local- currency deposits, and the central bank's flexible approach towards liquidity management.
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