Rate Cuts and Bank Profitability: A Looming Challenge for FY26

The Reserve Bank's rate cuts are set to reduce banks' return on assets (RoA) by up to 0.20% in FY26, driven by a decline in net interest margins. Crisil Ratings highlights that loan interest rates lower quicker than deposit rates. Banks' funding costs and systemic liquidity influence this financial shift.

The Reserve Bank's recent rate cuts are projected to diminish banks' return on assets (RoA) by up to 0.20% in FY26, according to insights from a domestic rating agency. Crisil Ratings has predicted that RoA could contract to between 1.1% and 1.2% from a previous high of 1.3% in FY25.

The constriction in RoA is primarily linked to a similar dip in net interest margins. In a declining interest rate environment, loan rates tend to adjust faster compared to deposit rates. Crisil Ratings' director Subha Sri Narayanan points out that 45% of loan assets are pegged to an external benchmark, primarily the repo rate, and are typically adjusted rapidly post-rate cuts.

On the deposit front, reductions will only apply to new or renewed deposits, thus slowing down the liability side adjustment. Despite this, the Reserve Bank of India's recent liquidity measures, including tweaks in liquidity coverage ratio, offer some respite to lenders as they strive to navigate these challenging financial dynamics.

(With inputs from agencies.)