RBI's rate cuts to impact margins of top banks in FY16

Weak loan growth, capital constraints and lower margins make PSBs unattractive

The Reserve Bank of India (RBI) has cut benchmark rates by 50 basis points (bps) this year, which will have a direct bearing on the profitability of banks in FY16. Typically, net interest margins of banks tend to float downwards during the rate cut cycle. Analysts say in the previous rate cut cycle, net interest margins (NIMs) fell by 50 bps for public sector banks. Given that the liabilities (deposits) come with a fixed tenure, the transmission of lower rates tend to impact the asset (loans) side faster.

Private banks are better at asset-liability management than public sector banks. Suresh Ganapathy of Macquarie Capital does not expect significant benefits from treasury profits. RBI’s Basel-III liquidity coverage ratio rules will also keep a check on margins and the ability to monetise statutory liquidity ratio investments. Given the challenges facing public sector banks, analysts remain positively inclined on top private banks. Macquarie has an ‘underperform’ rating on all public sector banks.

Public sector banks are expected to clock lower loan growth in FY16, thanks to their capital constrains. As a result, public sector banks might not be best placed to capitalise on any pick up in loan growth. Other than asset quality and capital constraints, now public sector banks will also see erosion of profitability through lower net interest margins. According to Spark Capital, public sector banks are likely to see the twin pangs of lower growth and delayed NIM expansion, besides continued asset quality pains. In FY16, analysts see public sector banks clocking sub-10 per cent credit growth, which would further cap earnings.

Till last year, there were three trades in banking. The first one was that of improving macroeconomic fundamentals and reforms by the new government. This trade has already played out, believe analysts, as bank stocks are up 80 per cent in the past 12 months. Improving asset quality and loan growth were the other two plays that analysts were betting on. Loan growth is expected to remain at 10 per cent levels, much of which would be driven by retail and some bit of foreign disintermediation. According to Citi, an uptick in loan growth could precede the asset quality improvement, but the stock impact of such an event is less than top-down or asset-quality trades. The next round of stock price movement would largely be linked to balance sheet improvement, which is expected to take longer.