India Ratings and Research (Ind-Ra) believes that the beginning of reduction in savings bank rate by commercial banks will spur a new competition among them. This is likely to have asymmetric consequences for large public sector banks (PSBs), medium-to-small PSBs and private sector banks.
From the borrower's perspective, the agency analysed the top 500 corporates in terms of their balance sheet debts for an empirical understanding of the impact of the reduction in interest rate. The study construed that interest rates play a limited role for existing stressed corporates. Hence, resolving such stress will continue to be challenging without a meaningful recovery in the demand conditions, and low lending rates could catalyse such progression.
Saving Deposit Rate: New Paradigm
The profitability levels of Indian banks remain weak owing to the continued pressure on asset quality and low credit demand. It would be imperative for banks with adequate capitalisation to start gaining market share over weaker peers which are starved for capital. The agency believes with the interest rate cycle reaching the bottom, downward repricing of existing liabilities could facilitate a further reduction in rates. Few of the large banks cutting savings deposits rates over the last few days, which has long been agnostic to changes in the broader interest rate structure, is a move in that direction. Banks with comfortable capitalisation are favourably placed to expand their credit market shares in the current environment of anaemic credit demand and competition from the corporate bond market.
Ind-Ra highlights cutting savings deposit rate for amounts below INR5 million presents large PSBs, which have a stable, large and granular savings deposit base, with additional manoeuvrability over private peers to cut marginal cost of lending rate (MCLR). The maximum cut in MCLR for PSBs can be 35bp (assuming a 50bp cut in savings deposit rate); a cut in MCLR beyond 35bp would become a margin dilutive proposition.
For private banks, the threshold is 25bp (refer to sensitivity tables). This could intensify competition between large lenders with strong savings deposit franchise and capitalisation towards gaining credit market share while channelising some volumes in the commercial paper market towards bank credit.
Savings Rate to MCLR Transition Sensitivity Analysis: Ind-Ra's sensitivity analysis demonstrates scope for a reduction in MCLR, emanating from the reduction in savings deposits rates, under four different scenarios by PSBs and private banks. The analysis suggests that PSBs have more room for percolating savings banks rate cut into a reduction in MCLR than private banks, owing to a large base and sticky saving accounts. The green block denotes the maximum possibilities of a reduction in MCLR, under given conditions, without compromising interest margin.
Bond and CP Rates Close to MCLR: Short-term rates for commercial papers and rates for 'AAA' rated borrowers have plunged in response to sloshing system liquidity and favourable demand-supply conditions, which have made banks' lending rate costlier. However, in concurrence with the current development, banks can regain their market shares, while the scope for a further reduction in rates for the bond market appears limited.
Lower Interest Rates to Not Do Much to Relieve Corporate Stress: Ind-Ra believes that if bank rates were to decline from FY17 levels, it could provide some relief for debt servicing to vulnerable corporates (interest cover below 1x) in FY18-FY19, if transmitted to these borrowers. However, the credit profiles of these entities are unlikely to benefit much, owing to their weak operating metrics and cash flows coupled with high debt levels. An improvement in demand growth rather than lower interest rates will have a greater positive impact on the credit profiles of overleveraged entities.
At FYE16, 90 of the largest 500 listed and unlisted non-financial corporate borrowers had negative EBITDA while 97 had an interest cover below 1x, indicating the inability to servicing even interest obligations. The aggregate borrowings of these 189 corporates accounted for roughly one-third (INR10 trillion) of the aggregate borrowings (INR30 trillion) of the largest 500 listed corporate borrowers at FYE16.
If the EBITDA levels of the top 500 corporate borrowers grow in mid-single digits (as highlighted in the 'Corporate Risk Radar FY18', published on 1 June 2017) and interest rate reduce by 75-125bp from FY16 levels, only 22 corporates of the 97 are likely to show an improvement in their interest cover in the 1x-2x range. These 22 corporates contributing less than 10% to the total debt are likely to be in sectors such as power, iron and steel, telecom and real estate among others.
Conversely, a fall in rates has been more beneficial for corporate with strong financials, as banks have more room to pass the benefits.
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