Margin trends

Bank profits will moderate in coming quarters

The economic rebound following the pandemic has led to an acceleration in credit growth for banks with lower defaults. However, the financial sector needs to brace for margin compressions in 2023-24 (FY24) as deposit rates catch up with lending rates. A rising tide lifts all boats, and that definitely seems the case at the moment. In Q1FY24, scheduled commercial banks (SCBs) saw a 35 per cent year-on-year (Y-o-Y) increase in interest income to Rs 4.5 trillion from Rs 3.35 trillion in Q1FY23. Interest income also grew 5.8 per cent sequentially over Rs 4.3 trillion in Q4FY23. Non-interest income grew to Rs 1.06 trillion, an increase of 54 per cent Y-o-Y but lower than the Rs 1.26 trillion recorded in Q4FY23.

Loan recovery has also strengthened. Aggregated provisions reduced to Rs 32,278 crore in Q1FY24 from Rs 34,149 crore in Q1FY23. Non-performing assets (NPAs) dropped to a 10-year low by Q4FY23 and decreased further in Q1FY24 as loss-making borrowers experienced turnarounds. Taken together, this enabled listed SCBs to declare profits after tax of Rs 80,521 crore in Q1FY24 — a rise of 66 per cent Y-o-Y and 15.6 per cent quarter-on-quarter (Q-o-Q). Public-sector banks did especially well, more than doubling their profits. They also benefited the most from lower NPAs. Indeed, State Bank of India (SBI) overtook Reliance Industries to become India’s most profitable listed entity. Net interest margins (NIMs) were a key variable for banks. The NIM measures the surplus of interest income over interest costs. It had expanded to beyond 3.55 per cent in Q4FY23 from around 3.1 per cent in Q1FY23.

However, banks experienced a sequential contraction in NIM in Q1FY24, compared to Q4FY23. SBI, the largest lender, saw NIM fall by 27 basis points, for instance, while the management of the two largest private-sector banks, HDFC Bank and ICICI Bank, issued guidance flagging NIM compression for their respective institutions throughout FY24. The reasons behind banks registering higher NIMs in FY23 are not complex. The central bank increased the policy interest rate several times in FY23 in an attempt to rein in inflation. The Reserve Bank of India (RBI) also changed its accommodative stance, tightening the money supply. Although it has hit a pause on rate increases, it is still in the process of withdrawing liquidity. Commercial lenders like banks and non-banking financial companies passed on the policy rate hikes quickly, raising their lending rates. In the case of floating-rate loans, such as mortgages, which are linked to the policy repo rate, this happens automatically. However, banks delayed raising their deposit rates, since they were flush with deposits. This allowed for NIM expansion.

But rapid credit expansion through the last three quarters has meant that the credit-to-deposit ratio is now tight for most banks and, given the increase in demand for credit, the sector needs to attract more deposits. Consequently, deposit rates are now rising across the sector, and are likely to continue rising given the competitive nature of the industry. There isn’t much room to raise lending rates unless the RBI starts to increase the policy rate again. This will lead to NIM compression. Banks would still do well through FY24 due to the volume factor as credit demand expands, and fewer loans go sour during a recovering business cycle. However, the super-normal growth rates seen in the last two to three quarters may moderate.