Bank deposit growth to remain sluggish, margins to improve in Q2  

July 21, 2010

 As deposit growth slackens, funding credit growth to remain a concern along with NPA coverage; NIMs to improve in rising interest rate scenario

The last quarter of the financial year has been a trying one for many banks. They have had to deal with a multitude of regulatory requirements while trying to maintain profitability in a rising interest rate scenario. Several banks have had to cough up more funds towards provisioning for losses as well as adhering to the revised methodology of calculation of interest rates on savings deposits. Tight liquidity conditions brought forth by the impact of sudden outflow of cash to fund telecom companies' 3G fee bids and advanced tax payments put a lot of pressure on banks. On top of this, deposit growth slackened drastically towards the end of the quarter, creating a wide deficit against credit off-take.

The quarter witnessed bank credit off-take rising by nearly 20%. But that figure also needs to be seen in context. First, it is against a low base of the previous quarter. Second, a large chunk of this credit demand was at the fag end of the quarter, driven by corporate loans to pay off 3G fees. This was a one-time credit flow, and hence it will not be easy for banks to report similar credit growth going forward. So where does it leave the banking sector heading into the second quarter?

Clyton Fernandes, banking sector analyst at Anand Rathi feels that the high credit growth is not sustainable in the future and that inflation and a weak monsoon continue to be an overhang for credit growth. "If inflation comes off, it would mean lower working capital requirements for companies and hence lower credit growth. Also, if the global situation improves, banks abroad will start lending again and lot of corporates will opt for ECBs. A good monsoon will also ensure that some of the retail demand will pick up in the next quarter."

Looking ahead, banks with higher proportion of CASA deposits will feel a slight pinch on their margins, but the base rate, which kicks in this quarter, is likely to offset the impact appropriately. BRICS Securities explains, "With banks having to adopt daily average balance methodology in calculating interest on savings rates, various banks have indicated that their NIM could be impacted in the 15-25 bps range, which should have a meaningful impact on earnings growth. However, with the base rate era in place, the expectation is that most, if not all of the decline could be short-term as the increased cost would be incorporated into base rate and priced appropriately into loans."

HDFC Bank, State Bank of India and Axis Bank have the highest proportion of CASA deposits. As such, NIMs of these larger banks will be affected more compared with smaller banks like IndusInd Bank, IDBI Bank and Yes Bank.

Deposit growth was another worrying factor for many banks as the availability of low-cost funds slackened during the last quarter. As per RBI data, deposit growth was 13.9% y-o-y as on 19 June 2010, whereas credit outflow surged by 19.6% y-o-y. BRICS Securities expects this trend to continue over the next few quarters as banks compete on pricing to attract deposits, and as bulk deposits and wholesale borrowings pick up to fund incremental credit growth. It expects a combination of these two factors to partly offset the positive impact from a gradually rising interest rate environment.

Mr Fernandes points out, "It depends on how inflation pans out. Banks have to raise deposit rates because the real interest rate is currently negative. They will do so if they are confident of credit growth. However, they will not look at raising deposit rates very aggressively if they do not have a cushion on the yield side. Also, as banks do not have much pricing power on their asset side, they would not go full throttle on the liabilities side."

He believes that the current investment-deposit ratio of 32% provides a good cushion for banks to fund credit growth. "Banks have shown good loan book growth in the last quarter. They are liquidating investments and diverting that money towards this growth. This scenario is similar to the one in 2005 when investments as a proportion to deposits came down and credit growth picked up gradually."

Several banks have yet to make ground to adhere to the mandatory 70% provisioning requirement set by the RBI. Some of the larger banks like ICICI Bank and SBI have already received extensions until September 2011 to provide the necessary capital. "While this helps the banks to somewhat smooth-line the additional provisioning," says BRICS, "it nevertheless would put pressure on earnings over the next few quarters." It believes that SBI and ICICI Bank will be under pressure the most.

Starting this quarter, banks have started pricing loans according to the new base rate system introduced by the RBI. Under this system, banks will not be allowed to provide loans below a certain floor rate. The banking fraternity has fixed the initial base rate between 7%-8.5%. However, a lot of clarity is still awaited as to the actual working of the new pricing regime.
RBI has given flexibility to banks to readjust the base rate on a quarterly basis so as to enable them to arrive at the optimal rate. But with interest rates set to move further north, it is expected that banks will probably transfer the rate hike on to customers with a similar revision in the base rate.  — Sanket Dhanorkar