RBI Rate Cut Cycle To Hurt Large Banks' Interest Margin More, Says Nomura

The Reserve Bank of India's potential interest rate easing cycle is likely to have a higher impact on the interest margin of large private banks than their mid-sized or smaller counterparts, according to Nomura. That is because large private banks have 50–60% of their loan books directly linked to the repo rate and other external benchmarks.

A 50 basis point cut in the repo rate would impact large banks' net interest margin—which denotes a bank's profitability—by 15-20 basis points, Nomura said.

The RBI, in its August meeting, kept its benchmark lending rate unchanged at 6.5%. India's retail inflation dropped to a five-year low of 3.54% in July, below the central bank's key target of 4%. The easing price pressure comes as the US Federal Reserve prepares to turn dovish in its meeting next week, a key trigger for most global monetary policy decisions.

Smaller private banks such as IndusInd Bank Ltd., AU Small Finance Bank Ltd., and Bandhan Bank Ltd. have a higher share of fixed-rate loans, resulting in a lower impact on NIMs and return-on-asset. The State Bank of India, too, with a higher share of MCLR-linked loans, would see a lower impact of 12 basis points.

The ultimate impact on return-on-assets from a 50 basis point rate cut should be 5-10 basis points for large private banks, except IndusInd Bank. Government-owned banks could see a return-on-asset impact of 6–8 bps, Nomura projected.

Moreover, a potential 50 bps cut in the RBI's cash reserve ratio from the current 4.5% can aid NIMs by 3-5 bps. Although this will be offset by the higher liquid asset requirements via the implementation of draft new liquidity norms slated to be effective from April next year.

"Larger banks offer significant valuation comfort, and hence we do not see the need to move down the risk curve," Nomura said, adding its top picks remain Kotak Mahindra Bank Ltd., ICICI Bank Ltd., SBI, and Federal Bank Ltd.

Deposit Growth Likely To Improve

Nomura stated that deposit growth, which has been sluggish due to reduced money creation by the RBI last fiscal, is expected to pick up when the central bank adopts a more accommodative policy stance.

After the aggressive monetary tightening over the past two years, the current and savings account ratio declined by around 450 bps over fiscal 2022 to 2024 to 39.1%.

An increase in the CASA ratio can help mitigate some of the negative effects on net interest margin. For banks, a one-percentage-point improvement in the CASA ratio generally boosts NIM by approximately 4-5 bps, the firm said.

Target Price Action

Nomura reduced its target price for Axis Bank Ltd., SBI and Bank of Baroda Ltd. while reiterating 'buy' ratings, as it lowered its target multiple led by lower sustainable return-on-equity.

• Axis Bank: Target price decreased to Rs 1,370 from the previous Rs 1,435.

• SBI: Target price decreased to Rs 980 from the previous Rs 1,030.

• Bank of Baroda: Target price decreased to Rs 280 from the previous Rs 310.