New Delhi [India], October 16 : A research report has highlighted that even if the Reserve Bank of India (RBI) announces a rate cut, deposit costs in the banking system are expected to remain high due to the prevailing high credit-to-deposit ratio.
As a result, a cut in the repo rate would not immediately lead to lower deposit rates. The report indicates that deposit rates are "sticky" and slower to adjust.
"We believe the deposit cost for the system will remain high (sticky) due a high credit to-deposit ratio and a repo-rate cut is not likely to trigger an immediate deposit-rate cut" said the report by PhillipCapital, financial management company.
As per report, the margins for Indian banks are also expected to moderate over the financial years FY24-26 due to the anticipated decline in interest rates
"Empirical evidence and banks' pricing mechanisms for assets and liabilities suggests that (ceteris paribus) declining interest rates are not favourable for net interest margins and viceversa" said the report.
The relationship between interest rates and banks' net interest margins (NIMs) indicates that declining rates tend to reduce margins, while rising rates have the opposite effect. This is based on the pricing mechanisms that banks use for their assets (loans) and liabilities (deposits).
The report added that one of the main factors contributing to this expected moderation is the high credit-to-deposit ratio in the Indian banking system, which has kept deposit costs elevated.
Therefore, a reduction in the repo rate is not expected to trigger an immediate drop in deposit rates.
The report suggested that a 50 basis points (bps) cut in the repo rate is being factored in while forecasting margins for FY25 and FY26. However, despite this reduction, the high credit demand compared to available deposits could limit the impact of any rate cuts on deposit costs.
As a result, the profitability of banks, reflected in their net interest margins, may face downward pressure during this period.
"Yield on advances will stabilise in FY25, but cost of fund will increase at a slightly higher rate, translating into some margin compression in FY25" the report added.
Overall, Indian banks will likely experience a moderation in margins, even as borrowing costs potentially decline, as the cost of deposits remains relatively high and slow to adjust.
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