When the broad market expectation was a mere 25 basis points (bps) reduction to the repo rate from the RBI, the central bank delivered a surprise 50 bps cut. Bank stocks posted healthy gains on Friday with the Nifty Bank gaining 1.5 per cent to mark a fresh all-time high. What exactly are the implications for bank stocks? Here we decode the move and what RBI’s actions mean.
Clarity on margin trajectory
While it is true that banks have to transmit the benefit of rate cuts to the borrowers soon and that their yields would come under pressure, what appears to have comforted banks is the fact that the RBI has frontloaded much of the monetary easing that it could. The switch back to neutral policy stance from accommodative explains there might not be any more rate cuts in the near term. This provides clear visibility to banks which were any way preparing to tackle rate cuts up to 50 bps. This way, the transmission of rates to borrowers and a commensurate repricing of deposits can happen quicker.
That said, banks’ net interest margins (NIM) will come under pressure though, in the first couple quarters of FY26. This is because, loans will get repriced earlier than deposits. Within deposits, while the short-term bulk deposits get repriced quickly, retail deposits could continue to be sticky. Taking cues from the RBI Governor, historically the rate transmission cycles have been six-nine months long and he opined that the ongoing cycle is one of the fastest in history. Hence, NIMs can be reasonably expected to normalise at least by the end of this fiscal.
The latest data on rate transmission by all commercial banks combined since January 2025 (month before rate cuts) is presented in the infographic.
MCLR loans to aid PSU banks
Public sector banks might fare better in terms of NIM compression, owing to higher share of MCLR-linked (marginal cost of funds-based lending rate) loans in their portfolio. As per latest available data on RBI’s database, this is the MCLR:EBLR:other loan mix of public and private banks as of December 2024 was public banks – 51:45:4; private banks – 13:86:1.
EBLR stands for external benchmark linked lending rate. EBLR loans have to be repriced as soon as there is a change in the benchmarks such as repo rate and T-bill yields, irrespective of whether repricing happens in deposits or not. MCLR loans, on the other hand, are based on the movement in the cost of funds of a bank (deposits largely represent a bank’s funds) and hence transmit benefit to the borrower as and only when deposits reprice.
Growth in advances and deposits
Loan growth slipped to a moderate 11 per cent year on year in FY25, compared with a 20 per cent growth seen in FY24. This was partly due to elections and absence of a healthy demand for capex in FY25 (though picked up in the last quarter of FY25). There was also the HDFC factor. To bring down credit deposit ratio, the bank put loan growth on the back seat.
Now with rates slashed, loan growth in FY26 can be expected to be better than FY25. HDFC’s loan growth, too, is expected to be in line with the system in FY26.
Most banks already have a good pipeline of corporate loan sanctions. Demand can be expected from credit-dependent sectors such as infrastructure, real estate and automobiles. Retail loans could also see traction, supplemented by personal income tax cuts undertaken in the Budget.
With government spending picking up, deposits growth will be better too. Banks, too, are confident about deposit mobilisation, inferring from their prompt reduction in interest rates offered on term deposits and savings accounts, in response to repo cuts in February and April.
CRR surprise
What came as another pleasant surprise to banks is a 100-bp cut in the CRR (cash reserve ratio). The Governor noted that a CRR of 3 per cent is adequate and the reduction will free up ₹2.5-lakh crore worth of liquidity. This will prove to be a boon for banks, as this can ease the cost of funds and cushion the NIM compression to an extent.
Moving on, the rate cuts will help banks post good other income growth as well. As yields of government securities drop in response to the rate cuts, the AFS (available for sale) portfolio of banks will see MTM (marked-to-market) gains rise, some of which can become realised gains. This will boost the bottom line and return on assets.
While NIM compression may be a short-term overhang for bank stocks, the positives explained above outweigh the risk to margins.