Fluctuating bond yields key risk for banks' profitability, NIMs in FY22

Valuations likely to take 13-23 per cent hit if rates increase by 100-200 bps, say analysts

Post Wednesday’s monetary policy, 10-year bond yield once again softened to 6.0313 per cent on Thursday. While this is a sign of relief, given that it comes after a near 40-basis-point increase in rates seen in recent times, the Street is beginning to take note of the vast fluctuations in the bond yields.

For FY22, with reasonable stability setting in on loan growth expectations (though moderate at 10–12 per cent year-on-year) and asset quality issues more or less transparent, the major factor to watch out for would be the behaviour of bond yields, as it can impact the profitability or net interest margin (NIMs) of banks and consequently stock valuations. Analysts at Edelweiss note that a 100–200 bps increase in rates could mean a 13–23 per cent haircut to their target multiples or valuations. “We believe that in the environment facing today’s bank stocks, the key risk factor has become the interest rate- inflation- external account dynamic,” they add.

NIMs could be impacted for two reasons. Deposit mobilisation, both CASA (current account–savings account) and term, has been healthy despite bank interest rates at multi-year lows. Recently, HDFC Limited hiked its deposit rate by 25 basis points across categories. While this is a deposit taking non-bank adjusting in interest rates to match the fluctuating bond yields, if the instability in bond rates persist, banks too may have to make the adjustment.

With industry’s blended cost of funds at less than 5.5 per cent, a spike may have an immediate bearing on NIMs. Secondly, if lending rates have fallen in tandem to a 15-year low, low cost of funds play a significant role. A few days ago, State Bank of India (SBI) restored its home loan rates to 6.95 per cent from the concessional 6.7 per cent it offered till March 31, 2021. While the increase in rate is 25 basis points and SBI’s home loan rate remains cheap in the market, the reversal of pre-concessional rates suggests that across the board, banks may not be comfortable with such low lending rates for long, given the uncertain territory of bond yields.

Short-term loans such as personal loans and gold loans, having less than 12-months tenure, may be repriced without affecting the NIM much and yet remain stable and high growth products. But, the same cannot be said for long-term products such as home or vehicle loans, where interest rates play a significant role in the consumer’s buying decision. In these cases, loan growth too may be impacted if lending rates spike. Higher bond yields could also impact treasury income of banks. Clearly, bond yields will play a crucial role in determining growth and profitability of banks in FY22.