Analysts see limited impact of base rate cuts on banks’ margins

At a time when most bankers are crying foul about the likely negative impact of base rate cuts on their net interest margins (NIM), analysts believe otherwise. Firstly, most of the banks have already cut their deposit rates in select maturities over the last 4-5 months. 

“The cuts in deposit rates coupled with reasonable liquidity and lower wholesale funding rates has been leading to reduction in cost of funds and was reflected in better margins in December 2014 quarter and likely in March 2015 quarter as well,” says Manish Karwa, research analyst at Deutsche Bank. He says that while margin impact of these cuts will be limited, any further rate cuts over the course of the year will impact NIMs for the banks. 

Ajay Srinivasan, Director, CRISIL Research, echoes this view. “Lowering of base rate indicates the cost of funds for banks has declined, since base rate is calculated using deposit rates as the benchmark. Thus, decline in base rate would not impact net interest margins (NIMs).” 

On the contrary, CRISIL Research expects NIMs to improve slightly in 2015-16, backed by a gradual economic recovery and improving proportion of retail loans, which have higher yields, he says.

Last week, three large banks- SBI, ICICI Bank and HDFC Bank cut their base rates by 15-25 basis points post RBI’s monetary policy. Experts believe these cuts were long overdue given that RBI has already cut rates by 50 basis points in 2015 so far. While other banks could also trim their base rates, the impact of these cuts will be limited. 

State Bank of India officials estimate about Rs 1,200-1,300 crore hit on interest income due to 15 basis point cut in base rate. Analysts believe SBI could witness a 4-5 basis points NIM impact while for ICICI Bank, the hit could be of about 5-6 basis points. In case of HDFC Bank, the impact will be negligible given that a relatively low (20%) proportion of its loan book is linked to the base rate. In case of ICICI Bank and SBI, this ratio stands at 50% and 80%, respectively. However, NIM movement is not contingent on just rates and is determined by other key factors such as credit costs as well.

Bank NIM (%) Base rate (%)
SBI 3.2 9.85*
PNB 3.2 10.25
BoB 2.2 10.25
ICICI Bank 3.5 9.85*
HDFC Bank 4.4 9.75*
Axis Bank 3.9 9.95*
NIM: Net interest margin as on 31st December, 2014    
*Revised base rates    

Meanwhile, for the quarter ending March 2015, Vaibhav Agrawal, VP Research – Banking, Angel Broking, says, “We believe banks’ NIMs should improve in the March 2015 quarter due to 3-4 basis points savings in cost of funds. Notably, March quarter would have the full impact of deposit rate cuts and hence may aid NIMs. However, higher credit costs on account of increased non-performing assets could offset these gains to some extent”, he says.  

IDBI Bank executives, too, indicate that when clubbed with credit costs – amounts set aside for stressed loans – NIM impact will be more pronounced. Thus, public sector banks which have much higher credit costs as compared to their peers in the private sector will witness higher margin contraction. The actual impact though will vary from one bank to another.

“We believe bank-specific NIMs would vary quite meaningfully. Historical margin profiles show that the movement of bank-specific margins in an easing/tightening cycle are dependent on other factors as well, such as share of fixed rate loans, share of wholesale deposits and changing asset-liability profile”, analysts at Ambit Capital said in a recent report. They believe IndusInd Bank is best placed to protect its margins due to its high fixed rate portfolio, higher share of floating rate liabilities and improving liabilities.

While most analysts believe the margin impact for banks will be limited, some have a contrarion view. Adarsh Parasrampuria of Nomura says, “Given that banks have cut deposit rates by 25-50 basis points in the last 6-9 months, we would expect them to accelerate base rate cuts now. This will have a negative impact on bank margins, especially for PSUs, in the interim. We believe bank margins, especially for corporate/PSU banks, will be negatively impacted, due to faster transmission in a falling rate environment. The impact on retail private banks will be lower, given 40-50% of the loan book is fixed in nature.”