Banks Brace for Margin Squeeze Amid Anticipated RBI Rate Cuts in FY26

Indian banks are bracing themselves for a possible squeeze in net interest margins (NIMs) as the Reserve Bank of India (RBI) appears to be switching gears toward a more accommodative monetary policy posture. The RBI's recent cut of 25 basis points (bps) in its repo rate to 6.25% signifies the onset of a rate-cutting cycle for stimulating economic growth with declining inflation.

Easing Inflation Opens Door for Monetary Easing

Retail inflation in India continues to show a repetitive pattern. The March 2025 figures recorded inflation at 3.34%, making it the lowest in over five years. Since it is depriving the food price index of its declining base, the move also affords the RBI precious elbow room to effect further rate cuts without any inflationary concerns. 

Nomura’s analysts see another 100 bps cut in the repo rate by the end of 2025 to balance growth and inflation. They expect the historical rate to be 5.00%, with successive cuts of 25 bps in upcoming policy meetings.

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Impact on Banks' Net Interest Margins

Concerns over banks' NIMs (Net Interest Margin) with further cuts are rising. Analyst estimates predict an average decline of 10 bps in the NIM of Indian banks in FY26 based on the RBI's repo cuts. This effect is expected to be felt more in floating-rate loans linked to external benchmarks, such as housing and SME loans. 

While the pass-through to loan rates is immediate, deposits take longer to reprice. This temporary mismatch tends to compress margins. Over and above banks, in segments where NBFCs are directly competing with banks, the NIM may also be put under pressure.

Market Reaction Reflects Margin Concerns

Equity markets have reacted cautiously to the RBI's rate cut. Banking sector stocks , especially public-sector lenders, slipped after the announcement. The Nifty Bank index lost about 1%, with Bank of Baroda, Canara Bank, Punjab National Bank, and SBI accounting for major losses. Investors' caution illustrates their worry about the possible squeeze in banks' profit margins.

Liquidity Conditions and Lending Dynamics

While the rate cut has come to fruition, banks have been dealing with tight liquidity conditions imposed since about mid-December. In January, the banking system recorded a liquidity deficit with a one-year high of above ₹3 trillion. The case has made banks concentrate on deposit mobilization rather than almost any loan disbursal, causing muted loan growth for six consecutive months until December. 

The RBI has promised to monitor liquidity measures closely so that the cuts are transmitted adequately to increased lending. Unless a cut in the cash reserve ratio is implemented, liquidity remains a concern and calls for aggressive easing continue.​

Outlook and Strategic Considerations

While the RBI will continue to pursue an accommodative monetary policy, it will present a challenging setting for banks due to thin margins and weak loan growth. Therefore, the banks may need to tweak their strategies regarding cost-cutting measures to enhance profits from alternative sources. 

The changing macroeconomic environment of global trade wars and inflationary trends will determine the RBI's policy rate setting and, therefore, influence banking performance for FY26.