The report adds that one of the key factors contributing to this expected relaxation is the high credit-to-deposit ratio in the Indian banking system.
The report highlights that even if the Reserve Bank of India (RBI) announces a rate cut, the cost of deposits in the banking system is expected to remain high due to the current high credit-to-deposit ratio.
As a result, lowering repo rates does not immediately lead to lower deposit rates. The report shows that deposit rates are sticky and slow to adjust.
“We believe the cost of deposits in the system will remain high due to the high credit-to-deposit ratio, and the repo rate cut is unlikely to trigger an immediate deposit rate cut,” said a report from treasury manager Phillip Capital. company.
According to the report, Indian banks’ profit margins are also expected to ease over FY24-FY26 due to expected fall in interest rates.
“Empirical evidence and banks’ asset and liability pricing mechanisms suggest that lower interest rates are unfavorable for net interest margins and vice versa,” the report said.
The relationship between interest rates and banks’ net interest margins (NIM) shows that lower interest rates tend to reduce interest margins, while higher interest rates have the opposite effect. It is based on the pricing mechanism that banks use for assets (loans) and liabilities (deposits).
The report added that one of the key factors contributing to this expected relaxation is the high credit-to-deposit ratio in the Indian banking system, which continues to drive up the cost of deposits.
Therefore, the reduction in repo rates is not expected to immediately trigger a decline in deposit rates.
The report suggested that a 50 basis point (bp) cut in the repo rate has been factored into the margin forecast for FY2025 and FY26. However, despite this reduction, the impact of interest rate cuts on deposit costs is likely to be limited due to high demand for credit relative to available deposits.
As a result, banks’ profitability, reflected in their net interest margins, may face downward pressure during this period.
“Prepayment yields are likely to stabilize in FY25, but cost of funds will increase at a slightly higher pace, leading to some margin compression in FY25,” the report added.
Overall, Indian banks’ margins are likely to be constrained as deposit costs remain relatively high and adjustments are slow, even though borrowing costs may come down. (Ani)
