Banking Profits Face Squeeze as Deposit Costs Rise, Lending Rates Lag

In the upcoming December quarter, banks are bracing for a hit in profitability due to lower net interest margins (NIMs). The surge in the cost of deposits, rising sharply this fiscal, is expected to outpace the corresponding increase in lending rates. This imbalance is likely to result in a squeeze on NIMs, a crucial metric for banking profitability.

Key factors contributing to this scenario include a notable rise of 70 to 120 basis points in term deposit rates, especially in the third quarter. Analysts are expressing concerns about significant margin compression, as the benefits gained from higher interest rates are being overshadowed by the need to attract funds through increased deposit rates.

Kaitav Shah, an analyst at Anand Rathi, warns, “There has been more than a 100 bps rise in deposit rates in the past six months, and that will reflect in margins. We saw a severe margin compression in the second quarter, and it will be similar, if not more severe, in the third quarter as well.”

Despite challenges, banks are expected to report increased profits year-on-year, driven by factors such as robust loan growth, stable asset quality, and fee income. The Reserve Bank of India’s 250 bps hike in the benchmark repo rate between May 2022 and June 2023 has played a role in this dynamic.

Analysts, including Manish Ostwal of Nirmal Bang Securities, stress that the margin outlook commentary from banks will be crucial. While expectations of a 10 to 25 bps compression in margins exist, healthy credit growth in retail, business, and recovering corporate segments is anticipated to support overall bank earnings.

Treasury income is expected to play a role in supporting earnings, with IDBI Capital analyst Bunty Chawla highlighting the positive impact of a 7-10 bps decline in the benchmark 10-year government bond during the quarter. Despite margin challenges, the continued momentum in various banking segments is poised to contribute to sustained improvement in asset quality ratios.