HDFC Bank is bracing for the margin impact of repo rate-cutting cycle

HDFC Bank’s net interest margin (NIM) for the quarter ending March (Q4FY25) has expanded 2-3 basis points (bps) sequentially and year-on-year to 3.46% after excluding the interest income on income tax refund worth ₹700 crore. While this is praiseworthy, it will be interesting to see how the bank deals with the Reserve Bank of India's (RBI) rate-cutting cycle, which is likely to be deeper than envisaged earlier.

The RBI has cut the repo rate in February and April by 25bps each to 6%. With the regulator projecting the consumer price index (CPI) or retail inflation for FY26 at 4%, there could be further rate cuts in the offing, with real interest rate, i.e. nominal repo rate minus inflation, currently at 2%. One basis point is one-hundredth of a percentage point.

During the post-earnings call, HDFC Bank revealed that nearly 70% of its loans are on a floating rate basis (a large chunk of them linked to the repo rate), with the rest being fixed-rate loans. The impact of the cumulative repo rate cut of 50bps will begin to show in Q1FY26 results, as there is a lag effect of about one to two months before the repricing of loans.

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The bank reduced the interest rate on savings accounts with balances below ₹50 lakh by 25bps in April and also repriced its term deposits lower for various maturity slabs. As loans get repriced faster than deposits, with most of the loans being on the floating rate, investors have to brace themselves for a negative impact on NIM in the short term.

Strengths and weaknesses

While NIM may come under pressure in the coming quarters, does the bank have a volume growth lever to counter it? The bank’s balance sheet expanded in the single digits at 8% for FY25. Unless the expansion rate picks up materially, it is likely that even net interest income (NII) growth may remain subdued at least for a couple of quarters.

Q4FY25 results are satisfactory with NII (excluding interest on income tax refund) growth of 7.9% on-year to ₹31,366 crore. While advances under management (including securitized loans) rose by 7.7%, deposits grew at a faster pace of 14.1%. Fee income growth stood at 6.3%, which was mainly driven by an impressive jump in income from the distribution of third-party products by 14.4% to ₹2,380 crore.

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Thus, core net income, a sum of NII (excluding interest on income tax refund) and fee income, grew by 7.5% to ₹39,866 crore. Given several one-off items in income and expenses during Q4FY25 and Q4FY24, it helps to focus only on the core net income comparison. For example, provisions and contingencies in the base quarter had a big component of floating provisions at ₹10,900 crore.

The bank’s asset quality continues to be resilient, with gross NPA (excluding agricultural loans) steady on-year at 1.1%, though slightly lower than 1.2% in Q3FY25.

The bank’s historical return on average assets (RoAA) over the past decade is in the range of 1.9%-2.1%. Even if a 10% growth rate in the bank’s total assets is assumed for FY26, the average asset base of two years, i.e. for FY25 and FY26, comes to ₹41 trillion. At 1.9% RoAA, it should yield a net profit after tax of nearly ₹78,000 crore for FY26.

Excluding the valuation of subsidiaries estimated at about ₹2.3 trillion from HDFC’s current market capitalization of ₹14.6 trillion, the standalone bank is valued at about 16x of net profit for FY26. However, investors might want to wait for the trough NIM in the coming quarters before taking a plunge.

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