Why NIMs Will Decline in F17/F18
The debate on NIM trajectory in Indian banks, especially corporate lenders, is becoming more important - Rather than focusing only on NPLs, there is more discussion on NIMs. In fact, following our note on SBI, "State Bank of India: Where Could We Go Wrong? (01 Nov 2016)", investors have challenged the view that NIMs will stay weak in F17 and F18.
A common perception is that as nonperforming loan (NPL) formation slows, NIMs will bounce back. We agree there will be quarterly volatility (depending on what happens to interest accruals on NPLs, etc, in a particular quarter). However, structurally, NIMs will be under meaningful pressure. We present three charts on this point.
Growing disconnect in lending rate cuts: The Reserve Bank of India (RBI) implemented the Marginal Cost of funds-based Lending Rate (MCLR) on 1st April 2016 to ensure better rate transmission. Since then, banks have been cutting MCLR as deposit rates decline.
However, while MCLR (which applies to new borrowers) is coming down, the base rate (which was retained for old lending) has been relatively sticky, implying no rate pass-through for earlier borrowers. There are differences in formula that are likely driving this, but it affects NIMs.
As MCLR has been in effect for only seven months, the bulk of loans are still linked to base rates. This is supporting yields in the entire loan book -- despite the cuts in yields on the front book. However, as time passes, and as banks cut the base rate and more loans are MCLR-denominated, there will be meaningful pressure on NIMs, in our view. While some of this will likely be mitigated by lower funding costs, it will still hurt NIMs in F17 and F18, we believe.
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