Markets
Banks’ margin party is drawing to a close
Summary
Reserve Bank of India’s June Financial Stability Report released last week highlights that the profitability of scheduled commercial banks (SCBs) continued to improve in FY23.
The stellar rebound in India’s banking sector performance has been in focus in the recent quarters. This is also corroborated by the Reserve Bank of India’s (RBI) June Financial Stability Report released last week.
The report highlights that the profitability of scheduled commercial banks (SCBs) continued to improve in FY23. Much of this is owing to the robust systemic bank credit growth and the sharp rise in lending rates, resulting in a significant improvement in the net interest margins (NIMs) of banks in the backdrop of RBI’s monetary tightening. NIM is a profitability measure for banks and broadly reflective of the difference between interest earned and expended. In FY23, the NIM for SCBs rose by a sizable 30 basis points (bps) to 3.7%. One basis point is one-hundredth of a percentage point.
But unfortunately, there could be some spoilers this year. Agreed, credit demand may remain supported this year too amid resilient domestic economic momentum and rising capital spending. But lending rates may have peaked, with RBI likely to keep rates on hold for now.
Meanwhile, a greater drag on NIM looks likely through a possible increase in interest paid by banks. Through last year, most banks have been increasing rates on term deposits in a bid to garner higher resources to support increasing demand for credit.
As per RBI data, SCBs’ weighted average deposit rate on outstanding rupee term deposits rose by 130 bps since May 2022 (when the RBI rate hike cycle began) to 6.37% in May 2023. During the same time, the weighted average lending rates on outstanding rupee loans rose by a smaller quantum of 99 bps to 9.78%.
Note that the trend has continued in the first two months of FY24 (April-May) as well. Unsurprisingly, the SCBs’ spread between these two rates narrowed for the seventh consecutive month, thus pencilling in a worrying outlook for banking sector NIM.
The data is even more compelling when viewed from the perspective of fresh deposit and loans, with the increase being much higher for deposit rates (211 bps) compared to lending rates (141 bps) in this rate hike cycle.
A sign of relief is that the rate on fresh deposits has edged lower continuously in the past two months. Still, a sizable easing in deposit rates looks unlikely. The banking sector continues to face intense competition for resource mobilization to meet healthy credit growth amid resilient domestic economic momentum. This is exacerbated with the tightening in banking system liquidity. Moreover, there are a few structural factors at play too such as channelization of household savings away from bank deposits towards market instruments in pursuit of higher returns.
RBI’s FY23 annual report highlights that household gross financial savings have been on a downtrend since FY18, barring a spurt in FY21 owing to covid-related income uncertainty. Even within this, financial savings in form of deposits fell to 3.5% of gross national disposable income in FY22 from 4.3% in FY20.
Coming back to the banking sector, given the competitive resource mobilization scenario continuing to exert pressure on the deposit rates, the narrowing in NIM is inevitable going ahead. With likely downside pressures on NIM, the monitoring and resolution of asset quality issues by banks will be crucial to ensure sustained profitability and strong capital buffers especially after a period of soaring credit growth.
This would keep the scars of 2015-2017 at bay, a time when the banking sector was marred with soaring non-performing assets, steep losses and depleting capital, triggering massive regulatory support and capital infusions.
