On Monday, credit rating agency Moody's Investors Service said that the net interest margins (NIM) of Indian banks are expected to increase at a faster pace compared to their peers in the emerging markets in the current financial year on account of the rising policy rate cycle.
When interest rates rise, margin spreads of banks will widen as interest income from loans and investments rises faster than the interest expense paid to depositors as interest rates rise.
In addition to that, banks will also witness an increase in their return on assets (ROA) as there will not be a likely increase in their credit costs as the lenders have made significant increases during the pandemic, it said.
Despite the increase in profitability of banks in a rising interest rate cycle, the banks also face higher credit costs due to the weakening of loan quality and rising provisions. However, the Indian banks will be able to retain their profitability as the recognition of bad loans in India comes with a lag.
In the case of India, the historic relationship between credit costs and inflation is distorted because of significantly delayed recognition of NPLs and bank restructurings that took place in 2016–18 when inflation was slowing. "We expect Indian banks' asset quality will improve in 2022–23 because of recoveries and write-offs of legacy NPLs," Moody's said.
The rating agency's focused is on banks of 10 emerging markets, including Argentina, Brazil, China, India, Indonesia, Mexico, Russia, Saudi Arabia, South Africa, and Turkey.
Other than India, banks in Saudi Arabia and South Africa are also expected to see an increase in their NIMs in FY23.
Moody's expects banks in Russia and Turkey to post larger increases in credit costs in 2022–2023. In a scenario where inflation accelerates materially and leads to significant rate hikes, credit costs will also rise in Argentina, South Africa, and Brazil.
The Reserve Bank of India (RBI) has increased the policy repo rate by 90 basis points (bps), once by 40 bps in April and another by 50 bps in the scheduled meeting in June.