Bank Margins Drop to 3.98%, Three-Year Low on RBI Rate Cuts

India’s banking sector saw average net interest margins (NIMs) narrow to a three-year low of 3.98% in the June quarter, as the Reserve Bank of India’s (RBI) 100 basis point repo rate cut exerted downward pressure on profitability. This marks a decline from the previous low of 3.82% recorded in March 2022. The fall is attributed to quicker adjustments in lending rates compared to slower declines in deposit costs, squeezing the banks' net margins.

Although short-term pressure is anticipated to persist, if deposit rates fall and the RBI decides against making any more rate reductions, there may be an improvement in the second half of the fiscal year.

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Widespread Impact Across Banking Segments

The margin compression has affected a broad spectrum of the banking industry, including:

• Public sector banks
• Private sector banks
• Small finance banks

However, a sample of 30+ banks across these categories was analysed, revealing the extent of the decline in NIMs.

Quick Resetting of Lending Rates, Lagging Deposit Yields

ET Intelligence Group data for the June quarter includes a mix of 37 banks—12 public sector, 21 private sector, and 4 small finance banks—all reflecting the margin squeeze. Many of these institutions have loan-linked products tied to external benchmarks. Since February, lending rates responded promptly to each repo rate reduction, while deposit rates lagged, failing to keep pace with policy easing. Analysts warn that this mismatch continues to put pressure on profitability into the September quarter.

Wider Implications for Profitability and Future Outlook

India Ratings and Research forecasts modest moderation in overall bank profitability for FY26, as banks navigate the dual challenges of narrowing margins and rising provisions. Despite expectations of credit growth (around 13%), slower NIMs and increased risk coverage may temper earnings.

Adding to challenges, corporate earnings in Q1 FY26 slipped to multi-quarter lows, particularly in sectors such as banking, consumer durables, and capital goods—highlighting the wider strains on financial performance arising from shrinking margins.

Conclusion

As RBI’s rate cuts drive lending costs lower, banks are grappling with the unintended consequence of lagging deposit repricing, compressing their NIMs to multi-year lows. Sustained margin pressure, combined with elevated credit provisions and weak corporate earnings, is likely to constrain bank profitability moving forward. A reversal might require stabilisation of deposit rates and an easing of monetary policy.