With the continuous re-pricing of bank term deposits at high rates, the cost of funding for banks is likely to climb by 25-30 basis points (bps) in the current fiscal year (FY25), reducing their profitability.
According to CRISIL Ratings, this may reduce banks' net interest margins (NIMs) by 10-20 basis points to 3.0-3.1 percent and lower their return on assets (RoA) to 1.1-1.2 percent in FY25, down from about 1.3 percent in FY24.
"Interest rates on new term deposits have virtually plateaued. The impact is still being seen when outstanding deposits come up for renewal, resulting in increased rates for current accounts. "This process should continue through the first half of this fiscal year," said Ajit Velonie, Senior Director at CRISIL Ratings.
Deposit costs have risen by around 140 basis points since the commencement of the rate-tightening cycle in May 2022. Profitability is projected to diminish because of increasing deposit costs as rates continue to rise. Deposit charges are likely to rise by 25-30 basis points this fiscal year, according to the statement.
While interest rates may fall in the second half of this fiscal year, the transmission of any rate cuts on the deposit side would be delayed due to the competitive market and restricted systemic liquidity, Velonie noted. Bank RoA is expected to moderate to 1.1-1.2 percent in FY25, down from a 20-year high of around 1.3 percent the previous year.
However, it will be healthy when compared to the long-term sectoral average of 0.75 percent over 20 years and the average of 0.5% over the previous ten years. Credit cost improvement, which has underpinned the banking sector's expanding profitability in recent years, is expected to bottom out this fiscal year, providing only a small counterbalance.
On the asset side, a rate decrease would result in faster re-pricing downwards because more than 40% of advances are tied to an external benchmark (External Benchmark-based Lending Rate, or EBLR), principally the repo rate. The re-pricing of deposits at higher rates, as well as the downward re-pricing of loans tied to external benchmarks on policy rate decreases, imply that NIM will be compressed in fiscal year 25.
