With the continued re-pricing of bank term deposits at elevated rates, the cost of funds for banks is expected to rise by 25-30 basis points (bps) in the current financial year (FY25), thus weighing on their profitability.
This may dent the net interest margins (NIMs) of banks by 10-20 bps to 3.0-3.1 per cent and moderate their return on assets (RoA) to 1.1-1.2 per cent in FY25 from about 1.3 per cent in FY24, according to CRISIL Ratings.
“The interest rate on fresh term deposits has largely plateaued. The impact is still flowing through to the outstanding deposits as they come up for renewal, resulting in the re-pricing of existing deposits at higher rates. This process should continue through the first half of this financial year,” Ajit Velonie, senior director, CRISIL Ratings, said.
The deposit costs have risen by about 140 bps since the start of the rate-tightening cycle in May 2022.
The expected moderation in profitability is on account of the higher cost of deposits given the continued re-pricing at elevated rates. Deposit costs are expected to increase 25-30 bps this financial year, the statement said.
While interest rates may come down in the second half of this financial year, the transmission of any rate cut on the deposit side would be slower given the competitive environment and the tight systemic liquidity, Velonie added.
Also Read
The moderation in RoA of banks to 1.1-1.2 per cent in FY25 would come after touching a 20-year high of about 1.3 per cent in the previous financial year.
However, it will be healthy compared with the long-term sectoral average of 0.75 per cent over 20 years and an average of 0.5 per cent over the past 10 years.
The improvement in credit costs, which has supported the rising profitability of the banking sector in recent years, is likely to bottom out this financial year and will, therefore, provide only a partial offset.
On the assets side, a rate cut would trigger faster re-pricing downwards as over 40 per cent of advances are linked to an external benchmark (External Benchmark-based Lending Rate, or EBLR), primarily the repo rate.
The re-pricing of deposits at higher rates and the downward re-pricing of loans linked to external benchmarks on policy rate cuts indicate a compression in NIM in FY25.
The transmission on the assets and liabilities sides will continue well into FY26, CRISIL added.