Banks may see some margin uptick as RBI normalises policy

About the data: Interest rates on education loans for all listed (BSE) public and private banks have been considered for data compilation; Banks for which data is not available on their websites have not been considered. Data collected from respective banks' website as on September 3, 2020. Banks are listed in ascending order on the basis of interest rate i.e. bank offering the lowest interest rate on education loan (loan amount of up to Rs 20 lakh) is placed at top and highest at the bottom. Lowest rates offered by the banks on loan up to Rs 20 lakh has been considered in the table. EMI is calculated on the basis of Interest rate mentioned in the table for Rs 20-lakh loan with tenure of seven years (processing and other charges assumed to be zero for EMI calculation); *excluding GST

Indian banks may finally be able to boost their net interest margins after being on the defensive for the past two years.

An analysis by ICICI Securities shows that banks can expect margins to increase by 2-5 percent in the event of a 100 basis points increase in the benchmark rate. One basis point is one-hundredth of a percentage point.

Banks charge interest on the loans they give out and they pay interest on the deposits they accept from the public. Put it simply, the difference in the two is the net interest margin that the bank earns.

A faster transmission of policy rate cuts onto lending rates, thanks to the Reserve Bank of India’s (RBI) rule of using an external benchmark rate to price loans, has pressured margins for banks.

At the same time, banks have cut deposit rates deeply. While this has helped the lenders keep their margins steady, there has been so improvement so far. The benchmark rate that banks have adopted to price their loans is the repo rate.

This transmission pace will now come in handy for banks as the interest cycle is turning up. The RBI has begun rolling back extraordinary policy measures it took to ward off the pandemic impacts. With the repo rate becoming the effective overnight rate again, analysts now expect interest rates at various maturities to also inch up. A hike in repo rate is also expected in FY23.

Ergo, loan rates may climb and yields will improve for lenders. Large lenders have a strong low-cost deposit base which helps them to go slow on deposit rate hikes. As such, banks increase interest rates on loans faster than that on deposits during an upward interest rate cycle.

“Based on our assessment, we believe every 100bps increase in the benchmark rates will lead to 50-70bps repricing of advances for banks and consequent rise in yields,” the report said.

Another helping factor is that the share of floating rate loans is high for banks. ICICI Securities estimates that nearly 62 percent of loans are floating rate loans for private sector banks. For public sector lenders, this stands at 85 percent. Within that a sizeable part is priced using the repo rate.

“As of FY21, nearly 58 percent of floating rate MSME loans, 50 percent of floating rate home loans, 40 percent of floating personal loans and 20 percent of floating other retail loans are linked to EBR,” the report pointed out.

The question now arises is which banks will be able to maximise their margin benefits.

ICICI Securities analysts believe that State Bank of India (SBI), Kotak Mahindra Bank, Axis Bank and Federal Bank may see more benefits than others. SBI’s large deposit base, Kotak Bank’s cautious approach towards credit risk may help them. SBI stands to gain the most in terms of a favourable earnings impact.