The policy rate is cut 50 bp. At Dhanvela Small Finance Bank 70% of loans reprice at once while term deposits reprice over a year. What happens to net interest margin over the next four quarters?

Net interest margin dips about 26 bp in the first quarter, from 11.25% to 10.99%, then recovers to about 11.26% by the fourth quarter. Loans reprice at once and cost Rs 70 crore a year of interest; term deposits reprice only as they mature, and at full pass-through save Rs 72 crore. If competition lets Dhanvela cut deposit rates by only 30 bp, the margin ends about 13 bp lower for good.

A shop that cuts its selling prices today but keeps paying last month's rent for the next few months feels squeezed until the lease is renewed. A bank's margin moves with the gap in timing between its assets and its liabilities: whichever side reprices first sets the direction of the next few quarters. Dhanvela's external benchmarkA published rate, such as the policy rate, to which a floating loan’s interest rate is tied by contract, so the loan reprices automatically when the benchmark moves. loans reprice the day of the cut; its term deposits reprice only as each one matures.

Loan yield falls by 70% of 50 bp, 35 bp, to 17.65%, straight away: Rs 70 crore a year less interest income. Term deposits are 80% of deposits, and a quarter of them reprice each quarter, so deposit cost falls 10 bp a quarter, to 7.1% after four. Margin drops to 10.99% in the first quarter and recovers 9 bp a quarter as deposits roll over, ending about 1 bp above where it started. The two sides nearly match in the end because Rs 72 crore of deposit savings offsets Rs 70 crore of lost yield.

Three things, in order. The share of floating loans: the higher it is, the sharper the dip. The maturity profile of term deposits: shorter deposits shorten the dip. And how much of the cut Dhanvela can pass to depositors, which for a small finance bank competing for deposits against larger banks may be less than the full 50 bp. At 30 bp the margin settles about 13 bp below where it started, a permanent cost of about Rs 27 crore a year. The limitation: fixed-rate microfinance loans reprice as they run off over the following year, which would pull margins down further in year two.