Bank profitability to remain healthy despite NIM pressure, aided by RBI’s easing measures

The Indian banking industry’s return on assets (RoA) — a crucial metric of profitability — will decline 5-15 basis points (bps) to 1.15-1.25% this fiscal from a two-decade high of ~1.3% last fiscal as net interest margin (NIM) slips. It will still be at a healthy level considering the sector’s average RoA in the past 20 years is ~0.8%.

Further, the current expectation on NIM compression is lower at 5-15 bps than the previously estimated 10-20 bps, with the Reserve Bank of India’s (RBIs) recent monetary policy actions likely to ease — on a net basis — the pressure on the metric. This will also benefit overall profitability.

There were two key monetary policy announcements made by RBI on June 6, 2025. One, the repo rate has been reduced by 50 bps to 5.50% with immediate effect. Two, the cash reserve ratio (CRR) has been slashed by 100 bps to 3% of net demand and time liabilities (NDTL) and will be made effective through four tranches between September and November 2025.

The frontloading of the repo rate cut takes the total cut this cycle since February 2025 to 100 bps. Our earlier expectation was a total cut of 100 bps by the end of the current fiscal. Consequently, there would be a somewhat higher impact on the yield side of NIMs than previously expected.

This is because loans linked to external benchmarks such as the repo rate form ~45% of total advances of banks and are typically repriced rapidly after repo rate cuts. Additionally, ~30% of total loans are linked to the marginal cost of funds-based lending rate (MCLR) and these also get repriced, but with a lag and to a lesser extent. Therefore, the frontloading of rate cuts accelerates the decline in yield.

However, this impact would be more than offset by the CRR cut, which would have a dual benefit that will ease the pressure on NIMs.

One, there will be an income benefit from the flexibility to deploy the funds till now parked as CRR into interest yielding assets. Two, strengthened systemic liquidity after the CRR cut and the RBI’s other measures will ease the pressure on the cost of deposits.

The RBI’s recent monetary policy announcements come on the back of a general easing in liquidity conditions, aided by its stance and actions on maintaining adequate systemic liquidity, and positive moves on the liquidity coverage ratio (LCR) front.

Overall, the extent of NIM impact would vary for each bank, depending on the strategies they adopt on both the deposits and advances side. In turn, their deposit pricing strategies will depend on an interplay of factors, including the share of external benchmark-linked loans, credit-deposit ratio, liquidity coverage ratio, the NIM level, and growth aspirations.

One choice that banks can make is reducing their term deposit rates or savings accounts rates, or a combination of both. A reduction in the term deposit rates will apply only to incremental deposits and renewals, resulting in a slower transmission of the rate cut to the liability side. On the other hand, a decrease in the savings account rate is applicable to all outstanding balances, thus yielding a relatively larger NIM benefit.

NIM is a key factor that impacts the overall profitability of banks. But there are others that also have a bearing.

On the expenditure front, the decline in credit cost, which supported profitability over the last few fiscals, is unlikely to continue this fiscal, with gross non-performing assets expected to be rangebound at 2.4-2.6% (vs ~2.4% as of March 2025). Further, operating expenses and other income will remain flat.

Consequently, the compression in NIM will drive the moderation in RoA after accounting for tax implications, even as the banking system profitability remains above the decadal average.

(Krishnan Sitaraman is Chief Ratings Officer, Crisil Ratings Limited)