Indian Banking: How Net Interest Margins Shape Profitability

The Margin That Drives Everything

Ask how a bank makes money and the short answer is: it borrows at one rate and lends at a higher one. The gap, measured across its whole balance sheet, is the net interest margin (NIM). For most Indian banks, net interest income is the largest part of revenue, so NIM is the main engine of profit.

But NIM is not fixed. It moves with interest rates, with competition for deposits and with the mix of loans a bank makes. Understanding those moves is most of understanding bank earnings.

The Parts of NIM

NIM = (Interest earned - Interest paid) ÷ Average interest-earning assets

Illustrative example. A bank has ₹1,00,000 crore of interest-earning assets yielding 9%, and pays an average of 5.5% on ₹92,000 crore of deposits and borrowings.

• Interest earned: ₹9,000 crore
• Interest paid: ₹5,060 crore
• Net interest income: ₹3,940 crore
• NIM: 3.94%

Two things drive this. The yield on assets depends on what the bank lends to and at what rates. The cost of funds depends on how much cheap money it can raise, especially current and savings account (CASA) deposits, which pay little or no interest.

Repricing: Uneven Speeds on Each Side

Since October 2019, the RBI has required banks to link new floating-rate loans to retail borrowers and small businesses to an external benchmark, usually the repo rate. These are called external benchmark lending rate (EBLR) loans. When the repo rate changes, their interest rate changes within months, often at the next reset.

Deposits move more slowly. A fixed deposit keeps its rate until it matures, which can be a year or more away. Savings account rates are set by banks and tend to change rarely.

So the two sides of the balance sheet reprice at different speeds. When the RBI cuts rates, loan yields fall quickly while deposit costs fall slowly, and NIM is squeezed. When the RBI raises rates, the opposite happens at first.

A Worked Example: A 25 Basis Point Cut

Illustrative example. The same bank has ₹50,000 crore of repo-linked loans and ₹55,000 crore of fixed deposits that mature evenly over the next twelve months. The repo rate falls by 0.25 percentage points.

First year:

• Interest on repo-linked loans falls by 0.25% × ₹50,000 crore = ₹125 crore.
• Fixed deposits reprice only as they mature, so on average half the cut applies in the first year. Interest paid falls by about ₹69 crore.
• Net effect: about ₹56 crore less net interest income, a NIM drop of about 6 basis points.

Second year: all fixed deposits have repriced, so interest paid is ₹137.5 crore lower for the full year. The net effect turns slightly positive.

The squeeze is temporary, but it can be painful while it lasts, and a full rate-cutting cycle repeats it several times.

The Recent Rate Cycle

India has just been through both phases. In 2025, the RBI cut the repo rate by a total of 1.25 percentage points, to 5.25%. Banks with large shares of repo-linked loans saw their margins squeezed as loan yields fell faster than deposit costs.

In October 2026, the RBI reversed course and raised the repo rate by 0.25 percentage points to 5.50%, its first increase since February 2023, as oil prices and inflation risks rose. For banks, the first effect of a hike is usually a lift to NIM. The second effect, which follows over the next year, is higher deposit costs and possibly slower loan demand and weaker borrowers.

The Deposit Franchise

A bank's ability to gather cheap deposits is one of its most valuable assets. A high CASA ratio lowers the cost of funds and makes it less sensitive to rate moves. Banks with weaker deposit franchises must rely more on fixed deposits and wholesale borrowing, which cost more and reprice faster.

Watch the credit-deposit ratio too. When loans grow much faster than deposits, banks must compete harder for deposits, which pushes up deposit rates and compresses NIM even without any change in the repo rate.

NIM Is Not Profit

A high NIM can come from lending to riskier borrowers at higher rates. If those borrowers default more often, the extra margin disappears in credit costs.

Lender Y looks twice as profitable on NIM. After credit costs, the two are identical, and Lender Y carries far more risk of a bad year. Unsecured personal loans and microfinance usually carry high NIMs for exactly this reason.

From NIM to ROE

NIM is the first line of a simple tree. All figures below are shares of average assets.

Each line can move. But because NIM is the biggest number in the tree, a change of even 0.2 percentage points in NIM can move ROE by more than one percentage point.

Habits for Reading Bank Margins

1. Check the share of EBLR-linked loans. The higher it is, the faster NIM reacts to rate changes.
2. Track CASA share and cost of deposits each quarter.
3. Watch the credit-deposit ratio for signs of deposit competition.
4. Look at risk-adjusted margin, not just NIM.
5. Build the ROA tree to see which line is driving ROE.

The Reframe

NIM tells you how wide a bank's spread is today. Repricing tells you where it is heading. Credit costs tell you how much of it the bank will keep. Read all three together.