Public sector banks, with a large deposit base coming particularly from savings account holders, are likely to get caught in a Catch-22 situation as the interest rate downward cycle begins this year.
Net interest margins (NIMs), or the spread between the lending and borrowing rate, are expected to come under pressure as lending rates will follow the drop in the Reserve Bank of India's (RBI) policy rate.
But reducing the interest paid to their large pool of savings-account holders is not an option even after a cut in fixed deposits rates begins.
"Deregulation on savings account rates also means we should be able to reduce the interest rates. If it was not for government ownership, they would have reduced the savings rate by now," said a senior executive with a public sector bank.
All public sector banks offer an interest rate of 4% on the savings account, much less than many private banks.
"The minimum balance requirement in savings accounts is very nominal and fees on most services are waived off," the official added. "Here we find ourselves in a fix because on the one hand we can't charge for any service; on the other, if we start giving higher interest rates, how do we earn?"
Deposit growth has also taken a significant beating this year as higher inflation and lesser growth in salary have hardly left anything for consumers to keep away with the banks.
The annual growth in bank deposits fell sharply to 11.05% as on December 28, the lowest since May 2003, according to data released by the RBI. A cut in the deposit rates can further hamper a bank's ability to attract deposits.
"In particular, government banks may see greater compression as they have a higher share of floating-rate loans with longer-tenor liabilities that re-price with a bigger lag leading to greater margin compression when rates are cut," said Rajeev Varma and Veekesh Gandhi, analysts at Bank of America Merrill Lynch.
The analysts added that even though margins are important, if rate cuts do provide some uptick to demand, the overall net interest income impact may be less if rate cuts help volumes. However, that is more likely to be in the second half of the year.