Banks' profit margins could potentially reach their ceiling, according to a CARE Ratings expert.
In the current economic climate, the Indian banking sector is experiencing a shift in its Net Interest Margins (NIMs) due to a notable decline in demand across key retail sectors such as housing and automobiles.
According to RBI data, the weighted average fresh term deposits rates for scheduled commercial banks have decreased by 44 bps during the same period. Despite this, system-wide NIMs have fallen to about 3.5% as of March 2025. However, fresh loan spreads have widened, particularly among private sector banks, which increased spreads by 34 basis points to 3.86% in May 2025. Public sector bank spreads rose by 6 basis points to 1.79% during the same period.
The widening spreads, occurring amid ongoing rate cuts (the RBI has reduced the repo rate by 100 basis points since February 2025), indicate a cautious approach by banks towards credit expansion. This cautiousness is primarily due to margin pressures and subdued retail credit demand, particularly in sectors like housing and auto where demand is weak.
The RBI's monetary easing, aimed at supporting growth and lowering borrowing costs (repo rate cut to 5.50% as of June 2025), may incentivize private investment. However, the subdued demand in key retail sectors like housing and automobiles dampens credit growth, which is a headwind for NIM expansion.
Some banks with strong retail lending exposure, such as HDFC Bank, may still see NIM expansion driven by their focus on higher-yielding retail assets and better loan pricing power, even as overall housing and auto loan demand remains low.
In contrast, the stress in the microfinance sector, according to Sanjay Kumar Agarwal, senior director at CARE Ratings, may ease in one year. Agarwal also expects bank lending to pick up for smaller and mid-sized Non-Banking Financial Companies (NBFCs), with banks becoming comfortable lending for 6-9 months.
However, the banking system is currently trying to protect NIMs, but Agarwal expects this to be sustainable for only a quarter or two months. NBFCs experienced muted growth in Q1 due to lower disbursements and higher slippages.
Agarwal predicts future demand for credit will come from the MSME and manufacturing sectors. He states that bank lending to smaller borrowers has been restricted for about 6-9 months but has now stopped. He does not mention any specific reason why the RBI stopped foreclosure fees on loans to small borrowers.
Despite the challenges, there is a steady demand for sectors such as renewables and roads, but housing demand is slightly weak. Private banks are letting credit growth lag behind deposit growth, while there are mixed discussions about this in public sector banks.
In summary, while the RBI’s monetary easing supports lower funding costs, pressure on lending margins persists due to weak demand in housing and auto sectors, resulting in cautious credit growth and a mixed outlook for NIMs. Private banks might sustain or slightly improve margins through wider spreads on fresh loans, but system-wide NIMs are unlikely to expand significantly without a recovery in retail credit demand.
- The decline in retail sectors like housing and automobiles has led to a notable shift in the Net Interest Margins (NIMs) of the Indian banking sector, affecting both public and private sector banks.
- In the face of ongoing rate cuts by the RBI, fresh loan spreads have widened significantly, particularly among private sector banks, as a cautious approach towards credit expansion.
- The subdued demand in key retail sectors like housing and automobiles, despite the RBI's monetary easing aimed at supporting growth and lowering borrowing costs, is dampening credit growth and inhibiting NIM expansion.
- The banking system is currently protecting NIMs, but Sanjay Kumar Agarwal, senior director at CARE Ratings, expects this to be sustainable only for a short period, while he predicts future demand for credit will come from sectors like MSME and manufacturing.
