RBI's Strategic Shift Towards Eased Liquidity

The Reserve Bank of India (RBI) is gearing up for a significant policy rate reduction, with a 50 basis points (bps) cut anticipated in the first half of 2025. This move follows the central bank's recent adjustments towards eased liquidity, including a 50 bps reduction in the cash reserve ratio (CRR) during the last Monetary Policy Committee (MPC) meeting.

Impact on Banks and Asset Quality

While the proposed rate cuts aim to stabilize regulatory momentum and foster economic growth, they may also temporarily affect banks' earnings. A potential 10 bps decline in net interest margins (NIMs) could reduce earnings by 3–8 per cent, with public sector banks likely to be the most impacted.

Despite stable deposit rates, the cost of funds for banks has seen an increase of 10–50 bps over the past year, attributed to repricing and shifts in funding mixes. Moreover, asset quality pressures, especially in unsecured retail loans and SME loans, continue to be a concern.

Future Outlook

Looking ahead, the banking industry is expected to benefit from the anticipated rate cuts and an improvement in asset quality by FY26. However, challenges such as NIM compression and stress in the Microfinance Institution (MFI) segment could pose short-term hurdles for public sector and mid-sized banks.