Amid the ongoing HDFC leadership change, discussions have focused on NIM volatility, a commercial yield that reflects the qualitative structure of a bank’s balance sheet. This encompasses liquidity conditions, liquidity costs, the composition and risk-based pricing of deposit and loan products, duration risks, and regulatory risks built comprehensively into the ALM structure.

NIM is the tip of the iceberg; its depth and potential depend on the composition of ALM, the structural mix of assets and liabilities that evolves with an institution’s vision and its capacity to harness its customer base and respond to market conditions.

A sustained NIM, rather than one measured at a single point in time, can reflect ALM efficiency. Strong ALM control can improve NIM management, making it a key competitive differentiator. India's average NIM, at around 3.3-3.75%, sits well above the global average of 1.63% and far above China's and the Eurozone's sub-2% margins—closer to levels seen at US banks. NIM tends to drop as markets evolve. 

Pricing Evolution
Historically, banks have moved from a regulated interest-rate structure to an autonomous ecosystem. This has been a continuous journey towards balancing interest deposit and lending rates within the letter and spirit of RBI guidelines. The pace of interest-rate transmission remains under regulatory scrutiny. NIM reflects market maturity; it falls as markets deepen and users become more price-sensitive.

Banks were permitted to fix interest rates on domestic term deposits with maturities of over two years in October 1995, and this was extended to tenors exceeding one year in July 1996. The RBI subsequently granted complete pricing freedom across all domestic term-deposit tenors, down to 30 days and later 15 and 7 days, subject to board-approved policies. The last administered deposit rate was eventually fully deregulated, allowing banks to set their own savings deposit rates, provided they offered a uniform rate on balances up to ₹100,000 while being permitted differential, tiered rates above ₹100,000. RBI removed this restriction on SB interest rates in February 2016. Depending on ALM and business priorities, ALCO sets deposit pricing across different durations.

Similarly, credit risk assessment and risk-based pricing, through lending rates for different loan products and durations within the regulatory framework, are critical competitive factors impacting NIM. Banks' lending rates were deregulated in 1994. Since then, the RBI has introduced several measures to improve transparency and ensure that lending rates reflect credit risk, although differences in individual cost structures and loan-asset mixes have made comparisons challenging.

The deregulation of lending rates began with Prime Lending Rates for loans over ₹200,000 (PLR, 1994-2000), Tenor-linked PLR (2000-03), Benchmark Prime Lending Rates (BPLR, 2003-2010), and the Base Rate system (2010-2016). Marginal Cost of Funds-based Lending Rates (MCLR, 2016) and External Benchmark Lending Rates (EBLR, 2019) now coexist. Bank lending rates have therefore undergone several pricing phases, each designed to improve on the previous one while balancing banks' and borrowers' interests and allowing adequate transition time.

Broad NBFC lending rates are largely deregulated under the Fair Practices Code (FPC), issued in September 2006, requiring NBFC boards to establish transparent, risk-graded pricing policies. Thus, regulated arbitrage between banks and non-banks is maintained, as they serve different borrowers but collectively support enterprise development.

Despite the development of various well-tailored lending-rate frameworks, the method for computing the credit risk premium and loading the components of MCLR remains unclear, even though the Key Fact Statement (KFS) specifies the annual percentage rate of interest and other terms. The RBI gradually introduced the KFS from 2015 and subsequently harmonised it into a mandatory universal framework for all retail and MSME loans in April 2024, effective October 1, 2024.

Towards Harmonisation
To increase transparency and phase out arbitrariness in lending rates, the RBI proposed harmonising lending rates in its monetary policy on August 5 and accordingly issued draft guidelines for banks and non-banks. The key objectives are (1) better monetary policy transmission, so a repo rate cut actually reaches borrowers faster; (2) appropriate and fair pricing of credit risk; and (3) non-discriminatory treatment of borrowers.

The draft guidelines require all loans, fixed- and floating-rate, to be priced using the relevant benchmark plus a risk-based spread, with clearly defined components and a hard floor preventing pricing below the benchmark. Floating-rate loans must reset the benchmark at least once every three months to ensure prompt transmission. The spread must be broken down into Credit Risk Premium (CRP), operating costs, term premium, and business strategy premium. CRP can change only after a formal review of the borrower's credit profile, while non-credit risk components cannot be increased for at least three years on floating-rate loans.

Protection for small borrowers and agriculture is ensured through a mandatory ceiling on the Annual Percentage Rate (APR), inclusive of all fees, for microfinance and small-ticket loans up to ₹50,000 to curb usurious rates. Interest compounding is also standardised, with monthly rests on a reducing balance and a crop-season rest for farm loans.

The new norms will improve transparency by unveiling the components of the credit-risk load in lending rates and breaking down the benchmark versus the bank markup in the loan agreement. Rate cuts by the RBI will be reflected in EMIs much faster, rather than being delayed by annual review cycles. NBFCs can move to EBLR, but it is not mandatory. However, they must also offer quarterly-reset floating loans with a uniform reset clause for banks and non-banks.

The stakeholder-comment period has ended, and the RBI can release the final guidelines at any time. They will take effect from April 1, 2027, for new loans, while existing loans must be mapped to the new regime by April 1, 2029, with no migration fees or immediate rate hikes for borrowers. This lending rate reform closes the gap between banking and shadow-banking credit standards, ensuring fair treatment and transparent pricing irrespective of the institution from which a loan is availed.

All lenders must maintain board-approved pricing and delegation policies, reviewed annually. Lenders have sufficient time to strengthen data-integrity standards across the components of the credit risk premium. With greater transparency around loan pricing, banks can create quality differentiation through ‘ease of doing business’, improving turnaround times and simplifying lending procedures, including documentation, disbursement, follow-up, and recovery. Thus, harmonising lending rates could be another step towards creating value for stakeholders across the lending lifecycle.

Streamlining deposit pricing and risk-based loan pricing, together with market liquidity conditions, will determine the ALM structure and its risk-based pricing, ultimately shaping a bank's NIM. While NIM is disclosed quarterly, ALM is an evolving structure shaped by customers' savings behavior and regulatory dispensations.

Hence, NIM-centric performance assessment may not be the right tool, as banks may tilt towards disproportionate near-term risk-taking to boost it, at the expense of long-term interests. A sustainable NIM within a tolerable range, coupled with more granular disclosure of ALM components, could create performance incentives for stronger integrated risk management.