Dollar inflows bolster Indian banks but squeeze private lenders’ margins

Foreign currency deposits raised liquidity at Indian banks but were initially deployed in lower-yielding assets, weighing on margins at several large private lenders, Jefferies says.

Foreign currency non-resident bank deposits are emerging as an awkward side effect of India’s drive to attract dollar inflows, with Jefferies saying the funding has helped liquidity but squeezed margins at several large private lenders.

The brokerage said the Reserve Bank of India’s decision to make it easier for banks to tap long-term NRI money under the FCNR(B) route gave lenders a fresh pool of foreign currency funds at a concessional swap cost. That helped shore up deposits at a time when pressure on forex reserves had made dollar inflows more valuable, but it also meant banks had to place the money quickly, often into assets that did not earn enough to offset the funding cost.

Jefferies said the result was visible in the September quarter, when private banks saw net interest margins come under pressure. Net interest margin, or NIM, is the spread between what a bank earns on loans and investments and what it pays on deposits and other borrowings. As the brokerage put it, the FCNR(B) money was initially deployed in lower-yielding assets such as liquid balances and corporate loans, with a gradual reallocation expected over the next two quarters.

The impact has not been uniform. Jefferies said ICICI Bank held part of the money as bank balances and expanded international lending, while Axis Bank increased corporate lending. HDFC Bank spread the deployment across several asset classes, and Punjab National Bank used the inflows to repay costlier liabilities while trimming exposure to lower-yielding purchased retail loans. The brokerage estimated the gross FCNR(B) mobilisation was equal to about 9% of ICICI Bank’s deposits at the end of June, 7% at Axis Bank, 3% at HDFC Bank and 2% at PNB.

That divergence showed up in quarterly performance. Jefferies said HDFC Bank’s margin fell 8 basis points sequentially, Axis Bank’s declined by 10 basis points and ICICI Bank’s dropped by 18 basis points, while PNB posted an 8 basis point improvement. Business Standard separately reported that in the second quarter of FY27, HDFC Bank’s NIM fell to 3.16%, ICICI Bank’s to 4.18% and Axis Bank’s to 3.36%, underscoring how the funding surge weighed on profitability even as it supported balance-sheet growth.

The near-term outlook remains mixed. Jefferies said private banks are likely to stay under margin pressure in the December quarter, although better deployment of FCNR(B) money should ease the drag over time. Seasonal stress in farm loans could also offset some of the benefit, while the eventual impact of the Reserve Bank’s rate moves will depend on how quickly lenders reprice their loans. In other words, the same inflows that strengthened funding positions may continue to be a headwind for earnings until banks work through the money more profitably.