State Bank of India SBI headquarters
SBI PO 2017 applicationsReuters file

Following State Bank of India's lead on Monday to sharply cut the marginal cost-based lending rate -- the rate at which banks now lend to new borrowers -- by 90 bps to 8 percent, rest of the PSU and private sector banks have no option but to follow suit. By Monday night itself, at least half a dozen banks announced the rate slash for different tenures.  

Comparison of interest rates on deposits by senior citizens after PM Modi's speech

While Punjab National Bank reduced the overnight lending rate by 70 basis points to 8.20 percent, Union Bank of India lowered the rates by 65-90 bps for different tenures. Similarly, Dena Bank, IDBI Bank and private sector lenders Kotak Mahindra Bank and ICICI Bank had to cut down rates.

SBI announced the cut a day after Prime Minister Narendra Modi asked banks to prioritise lending to the poor and the middle class. Banks are believed to be flushed with deposits following demonetisation of old high denomination currency notes of Rs 1,000 and Rs 500.

The move to cut the lending rate is expected to prompt an increase in credit offtake of banks -- especially of state-run lenders -- whose balance sheets are under substantial burden.

However, leading brokerages are of the view that cutting lending rates of such a sheer magnitude would squeeze the net interest margins of banks and the trend may well persist for at least a few quarters. 

In a report on SBI, a Deutsche Bank note warned: "A 90 bps one-go rate cut is sharp and will be negative for NIMs. Though this is only for incremental loans and the immediate impact on NIMs will be gradual, but pressure will persist for at least next 4 quarters as loans reprice downwards."

A CLSA report stated that the lending rate cuts will boost credit demand in retail segments such as housing loans and any impact on margins will be mitigated as MCLR will apply only to incremental loans, as reported by the Economic Times.

"A 5bps lower NIM in FY18 could impact earnings by 4%, with a higher impact on PSU banks," said CLSA.

Analysts expressed surprise at the quantum of MCLR cuts -- which they primarily believe is a result of demonetisation-led excess liquidity in the banking system -- and said the implication of the lending rate cut is likely to be negative for both banks as well as NBFCs, particularly catering to the housing loan segment.

Shares of banks and housing finance companies, including LIC Housing Finance, HDFC, Indiabulls Housing Finance, remained under pressure on Monday in trade and may continue to underperform in the coming weeks.