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Banks’ net interest margins (NIMs) will come under pressure as they gradually adopt the marginal cost of funds-based lending rate to price their loans, said Moody’s Investors Service.
Net interest margin is defined as net interest income (interest earned less interest expended) divided by average interest earning assets.
In December 2015, the Reserve Bank of India released guidelines for the banks' calculations of their lending rates. Under the new guidelines, the banks will gradually adopt the marginal cost of funds-based lending rate (MCLR) to price new loans approved after April 1, 2016.
Moody’s assessed that so far, less than 20 per cent of the banks' variable rate loans have been repriced to MCLR. Because the MCLR is around 85 basis points (bps) lower than the base rate, it expects the downward trend in net interest margins to persist.
“Before the new guidelines, Indian banks were allowed to set their base rates on either their average cost of funds, or marginal cost of funds.
“However, because the marginal cost of funds would result in a lower cost of funds – amid declining policy rates – the banks have not used it,” said Moody’s.
After calculating the difference between the median base rate as at March 2016 before implementation of the new RBI guidelines and the latest available median MCLR as at September 2016, Moody’s found that on an average, the differential between the base rate and MCLR is quite large, with the MCLR around 85 basis points (bps) lower than the base rate.
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