Result preview: Cost of deposits to weigh on banks' margins in Q1

Despite steady loan growth, the banking sector is expected to report subdued margins in the quarter ending June 2024 (Q1FY25), driven by high demand for deposits amidst tight liquidity conditions.

However, according to Bloomberg analysts, listed banks are forecasted to see a 14.5 per cent year-on-year (Y-o-Y) increase in net profit.

Estimates showed that banks’ net interest income (NII), and revenues from interest minus interest expenses might grow 11.9 per cent Y-o-Y.

Sequentially, NII may contract by 4.8 per cent on rising cost of deposits while net profit is likely to come down by 6 per cent.

Analysts believe that margin pressure will persist through the first half of the current financial year (FY25) due to ongoing repricing of banks' deposit books.

“Cost of deposits continue to inch up albeit at a more gradual pace than seen previously and we also believe that the system is possibly reaching a peak in deposit rates.

"This is likely to weigh on net interest margins (NIMs) in H1FY25 and thus keep NII momentum in check for the sector as a whole,” JM Financial said in a report.

The spread between outstanding lending rate and outstanding deposit rate for commercial banks stood at 2.89 per cent as of May 2024, and reduced by 1 basis point on month-on-month basis, reaching a nine-year low, according to CareEdge Ratings.

Senior bank executives said the cost of liabilities (deposits) have been rising while lending rates have stabilised, which has continued to put pressure on spread and NIMs.

Margins for public sector banks are expected to remain stable, given their lower loan-deposit ratio (LDR).

While the momentum in credit growth is expected to continue,

the widening funding gap has exacerbated concerns. Earlier this week, Reserve Bank of India (RBI) Governor Shaktikanta Das, in a meeting with chiefs of public sector and private sector banks, reiterated concerns on the widening credit-deposit growth gap.

Previously, the regulator had directed bank boards to re-strategise business plans.

“The persisting gap between credit and deposit growth rates warrants a rethink by the boards of banks to re-strategise their business plans.

"A prudent balance between assets and liabilities has to be maintained,” the RBI had said.

Asset quality of the banking sector is expected to remain robust.

However, recent developments related to farm loan waivers could potentially upset the credit culture and result in an uptick in credit costs, particularly in the agriculture and unsecured segments, said Motilal Oswal in a report.

“...We factor in a modest rise in provisioning expenses as recovery from the existing non-performing asset (NPA) pools moderates; the first quarter, being a seasonally weak quarter, is characterized by some rise in agriculture NPAs; and credit costs normalize gradually after being extremely benign over the recent period,” the report added.

While credit quality for banks have remained largely benign until now, “we expect it to normalise going forward and thereby build in an uptick in credit costs emanating primarily from retail segments”, JM Financial said.

Moderation in bond yields is expected to aid the income of banks in Q1FY25.

Overall, the 10-year G-sec yield fell by 5 basis points in Q1 to 7.05 per cent, continuing the softening trend.