Mumbai: Large private sector banks saw a year-on-year drop in net interest margins (NIMs) in the second quarter, as the cost of funds raised through foreign currency non-resident (bank) deposits and the low margins on lending backed by these funds weighed on profitability.

NIM is the difference between interest earned on loans and that paid for deposits. It is considered a key profit metric for banks. ICICI Bank, HDFC Bank and Axis Bank also showed a year-on-year drop in NIM, even as other profitability parameters remained stable.

ET Bureau

Analysts said the drop in margins was largely an after-effect of FCNR (B) deposits.

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"These banks took a hit both on deposit costs and lower margins on leverage. The large amount of deposits they garnered through FCNR (B) were heavily leveraged, and because margins abroad are just 50 to 60 basis points, it had an impact on overall NIM," said Siddharth Rajpurohit, lead banking analyst at Systematix Institutional Equities. "Also, as these funds were priced as term deposits, the corresponding impact on low-cost CASA deposits also hit margins."

For example, Axis Bank, which collected $10.62 billion through this scheme, saw a 34-basis-point impact as NIMs dropped to 3.46% in September from 3.80% a year ago. Executive director Subrat Mohanty said 11 basis points of the decline in NIMs can be attributed to FCNR (B).

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"The NIM decline can be attributed to the grossing up for self-leverage FCNR (B) deposits, and also due to the liquidity carry associated with these deposits, with surplus funds being parked in low-yielding securities prior to deployment in the appropriate avenues," Mohanty said.

For ICICI Bank, which was the largest grosser of FCNR (B) deposits, the impact on margins was also deep at 12 basis points, as NIMs fell to 4.18% from 4.30% a year ago. Although some of the hit was also because, unlike last year, the bank did not have any interest on tax refunds. Executive director Sandeep Batra said he expects some pressure on NIMs to continue as the full impact of FCNR (B) deposits is yet to play out.

HDFC Bank, which mopped up $11.5 billion through FCNR (B) deposits, also took a hit on margins as NIM dropped to 3.16% from 3.27% a year ago. HDFC Bank CEO Sashidhar Jagdishan said the bank's margins faced pressure from faster repricing of assets and a lag in the cost of funds during the declining interest rate cycle, along with the impact of FCNR (B). But as the rate cycle turns and the loan portfolio shifts towards retail and micro, small and medium enterprises, margins would improve, he said.