The Reserve Bank of India (RBI) is expected to reduce policy rates by 50 basis points (bps) in the first half of 2025, according to a report by Jefferies. This comes after the central bank eased its stance on liquidity and cut the Cash Reserve Ratio (CRR) by 50 bps during the last Monetary Policy Committee (MPC) meeting.
The Jefferies report states: "After easing stance on liquidity and CRR by 50bps, RBI may review policy rates; we see 50bps rate cuts in 1H25."
The report highlighted that the RBI's shift from a "withdrawal" stance to a more "neutral" liquidity position, along with the CRR reduction to the pre-COVID level of 4% of Net Demand and Time Liabilities (NDTL), has created the groundwork for a potential rate cut.
Such a reduction in policy rates is expected to stabilise the regulatory momentum, which could support growth and investment in the near term.
However, the report also noted that these policy changes might temporarily affect banks' Net Interest Margins (NIMs). A 10 bps decline in NIM could reduce earnings by 3-8%, with the impact likely to be more pronounced for Public Sector Banks (PSBs).
While deposit rates have largely remained stable, banks' cost of funds has risen by 10-50 bps over the past year due to repricing and changes in the funding mix.
The report further highlighted ongoing pressures on asset quality, particularly in unsecured retail loans and loans to small and medium enterprises (SMEs). Non-Banking Financial Companies (NBFCs) and smaller private banks catering to lower-tier clients have faced more significant stress compared to lenders focusing on upper-tier clients.
It stated, "Asset quality pressure may ease in FY26. There has been a divergent rise in asset quality pressure, especially from unsecured loans, with lenders focusing on upper-tier clients facing less pressure than NBFCs and smaller private banks that serve lower-tier clients."
The report expects asset quality pressures to ease in FY26, particularly in the unsecured retail loans segment. This improvement could occur as provisions for stressed assets are made upfront and new disbursals slow. The recovery in GDP growth is seen as a key factor for alleviating pressures on SME loans.
However, the Microfinance Institution (MFI) segment may continue to face challenges, potentially affecting earnings for mid-sized banks.
Overall, the anticipated rate cuts and the easing of asset quality pressures in FY26 are expected to provide tailwinds for the banking sector, although near-term challenges such as NIM compression and MFI stress could weigh on earnings.
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