The Indian banking system witnessed an improvement in the marginal lending spread by 7 bps in the month of April from March, according to Nomura. The lending rate on new loans also improved by 7 bps in April.

This was on the back of a 33 bps improvement for public sector banks even as private sector banks were down 28 bps on a monthly basis.

However, the lending rate on new loans was down since the cut in repo rate in February 2019. The average interest rate on term deposits and new deposits remained the same in April at 4.38 percent, Nomura said in a report.

Meanwhile, the average time-deposit rate on new deposits remained stable in April 2021 at 4.38 percent. The spread in the stocks of loans, i.e., lending rate on outstanding loans less deposit rate on outstanding deposits, declined marginally by 1 bps MoM to 3.84 percent.

Nomura expects the net interest margins (NIM) to sustain at the current levels seeing the conditions present in the economy.

"Banks delivered higher spreads through the COVID-19 phase, as credit disintermediation was low and loans could be priced better. If the cyclical recovery in loan demand picks up, banks may need to raise their retail deposit rates, even as wholesale deposit rates are off the lows since Jan-21," Nomura said.

However, banks will need to increase their deposit rates if loan demand picks up due to cyclical recovery. The banking sector would also need to keep an eye on the monetary policy that the RBI goes with.

A slower monetary policy move by the RBI may be negative on NIMs as new loans are being priced off the repo rate, the report added.

Though, banks do have countercyclical measures in the form of higher liquidity buffers they have been carrying since the start of the pandemic. Lower loan-to-deposit ratios and normalization for loans and deposits should easily offset any weakness, according to Nomura.

It remains hopeful about margins stabilizing at elevated levels for the banking sector.

Meanwhile, the lending spreads are near peak levels. The back book spread i.e., the difference between average lending rate on outstanding loans and deposit rate on outstanding deposits improved through CY20.

On the other hand, the incremental spread (i.e., on new loans and new deposits) declined in the early phase of the lockdown and has since improved. Comparing bank-group wise, the back book spread improved by 5 bps MoM for SOE banks in April 2021 and remained flat MoM for private sector banks., the report said.

The sharp divergence in spreads is mostly reflecting on the higher share of higher-yielding loans for private sector banks than SOE banks.