Banks may face further margin pressure as repo-linked loan rates reset faster than deposits, though liquidity support and CRR cuts could soften the impact in Q4
)
Experts suggested banks have been taking measures to protect their margins by changing their loan mix and doing more mid- to high-yield loans.
Listen to This Article
Net interest margins (NIMs) of scheduled commercial banks, which are already under pressure as deposit rates tend to adjust more slowly than lending rates, are likely to face further compression following the Monetary Policy Committee’s (MPC) decision to cut the repo rate by another 25 basis points (bps) in its December meeting. According to industry insiders, the impact of this additional rate cut will be felt in the final quarter of the current financial year (FY26). However, liquidity infusion by the central bank and the cut in the cash reserve ratio (CRR) are expected to partially cushion the impact on banks, unless the central bank goes for another rate cut in the next meeting.
The RBI’s six-member MPC cut the repo rate on Friday by another 25 bps, taking the total cut in the repo rate in the current easing cycle to 125 bps, from 6.50 per cent to 5.25 per cent.
According to RBI data, in response to the cumulative 100 bps cut in the policy repo rate, the weighted average lending rate (WALR) of banks has declined by 69 bps for fresh rupee loans during February-October 2025 (the interest rate effect is 78 bps). Additionally, the moderation in the WALR of outstanding rupee loans has been to the extent of 63 bps. Transmission has been broad-based across sectors.
Meanwhile, on the deposit side, the weighted average domestic term deposit rate (WADTDR) on fresh deposits has declined by 105 bps, while that on outstanding deposits has softened by 32 bps over the same period.
Since a large portion of banks’ loan portfolios is linked to external benchmarks that automatically reset when the repo rate is reduced, lending rates decline immediately. However, deposit rates take longer to adjust, causing banks’ NIMs to feel the squeeze during this transition period.
“We do expect that going forward, especially after this repo rate cut, deposit rates will to some extent moderate,” said Sanjay Malhotra, governor, Reserve Bank of India (RBI).
Banks have seen their margins compress in the first half of the financial year (H1FY26) as deposit repricing has been an issue, especially at a time when deposit growth has lagged credit growth in the economy. According to data, NIMs of private sector banks in Q2FY26 stood at 3.87 per cent compared to 4.02 per cent at the end of Q4FY25 — a drop of 15 bps. In the same period, NIMs of state-owned banks dropped 10 bps to 2.71 per cent in Q2FY26 from 2.81 per cent in Q4FY25. The drop in NIMs was sharper in Q1FY26 and in Q2 the banking sector delivered better-than-expected NIMs, even after absorbing the full impact of the 50 bp repo cut, supported by meaningful reductions in savings account rates.
“This (25 bps rate cut) will further impact banks’ margins as repo-linked loans reprice downwards by another 25 bps. However, we expect the impact of this to show up only in Q4 results as the transmission will fully happen next quarter only. Though PSU banks have a quicker transmission process and thus will see only partial repricing of lending yields in December quarter,” said Nitin Aggarwal, research analyst at Motilal Oswal.
“However, with gradual repricing of term deposits and benefits from cash reserve ratio (CRR) cut, the sector margins will still hold broadly stable in Q4FY26 unless RBI goes for another rate cut,” he said.
According to Anil Gupta, senior vice-president and co-group head, financial sector ratings, Icra, the interest margin for banks will be negatively impacted as the external benchmark-linked loans will reprice downwards shortly while the deposit base will get repriced downwards slowly. “However, the liquidity infusion measures shall improve the transmission of rate cut in bulk deposit rates, which can partially offset the pressure on NIMs,” he said.
Experts suggested banks have been taking measures to protect their margins by changing their loan mix and doing more mid- to high-yield loans. Recent data shows yields on fresh loans increased for both private sector banks and state-owned banks by 12 bps and 9 bps in October over September, respectively. With most of the repo-linked repricing already completed and MCLR easing at a calibrated pace, incremental loan yields have begun to inch up as banks actively reprice new loans at higher levels.
“We estimate FY26 NIMs of banks to be lower than that of FY25. With this 25 bps cut, the stabilisation in NIMs that we were expecting in the second half of the financial year (H2FY26) will now get delayed and is likely to be pushed to next year,” said an associate director, BFSI, CareEdge Ratings.
aniltikotekar4sme.com 