Liquidity easing to moderate Indian banks’ net interest margins pressure as rates fall: Fitch Ratings
Pressure on Indian banks’ net interest margins (NIM) from cuts in policy interest rates should be moderated by the Reserve Bank of India’s (RBI) easing of liquidity conditions for banks, says Fitch Ratings. The latest rate reduction is in line with Fitch’s assumptions, so is unlikely to drive changes in rated banks’ credit profiles.
Fitch estimates that Indian bank Net interest margins will fall by about 10bp on average in the financial year ending March 2026 (FY26) following the 25bp repo rate cut on 7 February, to 6.25%, and the additional 25bp cut that we expect in FY26. The impact ranges between 5bp and 15bp for Fitch-rated banks. The immediate effect will be felt on floating loans linked to external benchmarks, such as housing and SME loans, but will also be felt through fresh loans in a declining policy rate environment.
Non-bank financial institutions (NBFIs) may also experience NIM pressure in segments where they face competition from banks, such as near-prime urban housing or commercial loans. Fitch do not expect NBFIs’ borrowing costs from banks to ease by the same degree, as regulators seek to steer NBFIs away from over-reliance on bank funding.
The Indian banking sector’s NIM remains healthy, at 3.5% as of 1HFY25, although it has declined from about 3.6% in FY24, partly due to the upward repricing of deposits under the tighter liquidity conditions during 2024. We believe the sector’s NIM will trend towards the long-term average of about 3%, amid slower loan growth and lower yields.
Fitch does not expect pressure on Earnings and Profitability scores for Fitch-rated banks from rate cuts under our base case. Overall operating profit/risk-weighted assets (OP/RWA) is set to fall for most banks in the near term, but our scoring incorporates some headroom given our assessments take into account metrics throughout the cycle.
System liquidity pressures have moderated since late January 2025, due in part to RBI actions, including durable liquidity injections through open market operations and other, short-term liquidity measures, but has so far been insufficient for banks to lower their deposit costs. If banks remain unable to bring deposit costs down in line with falling policy rates due to tight liquidity, their NIMs could narrow faster than we expect. “This is not our base case, but as the liquidity situation evolves, alongside any further policy rate cuts, its impact on banks’ NIMs and overall profitability will be a key factor to watch,” says Fitch.
Under our base case, we anticipate that a moderation of loan growth, to 13% in FY26 from 14% in FY25, will ease funding requirements. We also believe additional measures by the RBI to improve liquidity are likely, and expect postponement of a proposed liquidity coverage ratio requirement that had been due on 1 April 2025 (in line with recent indications from the RBI governor) and of IFRS implementation. The reforms could otherwise tighten system liquidity and impact earnings – though the reprieve would come at the expense of continued regulatory forbearance.
High recoveries from written-off loans and lower operating costs due to increasing digitization may mitigate some of the NIM impact as policy rates ease. We anticipate that banks might also get some near-term support from delays in implementing higher deposit run-off rates and expected credit losses until after FY26. Lower rates may provide relief to higher-risk borrowers in retail and SME segments, but it still expect credit costs will rise as fresh loans underwritten in recent years age. Credit costs will continue to be the most important driver of the core OP/RWA metric due to banks’ moderate income buffers.
