Banking: Margin doldrums

Deposit rate wars and tight liquidity are likely to nibble at net interest margins

Despite the interim relief provided by the Reserve Bank of India (RBI), liquidity continues to be tight. Banks availed of Rs 1,18,320 crore through RBI’s repo window on December 7, while money market rates rose above the upper end of the liquidity adjustment facility corridor.

According to Edelweiss, the liquidity outlook looks grim, with advance tax outflows and corporate deposit redemptions of around Rs 55,000 crore and Rs 1 lakh crore, respectively, due in December-end.

Deposit growth has been lagging credit growth for some time (about 300 basis points year-to-date), despite a rise of 150-200 basis points in retail deposit rates, as compared to a 50-75 bps increase in lending rates since June.

Going ahead, as disbursements pick up pace, sector-wide retail term deposit rates are expected to rise 50-100 basis points, according to Macquarie research. State Bank of India has taken the lead, with a 100-basis-point increase in the one-two year maturity segment to 8.5 per cent. ICICI Bank isn’t too far behind.

Given funding cost pressures, it remains to be seen whether the growth in credit demand will allow banks to pass on the rate rise and protect net interest margins (NIMs). While divided about the quantum of impact, analysts unilaterally expect some degree of pain as far as NIMs are concerned. Edelweiss research estimates an average margin impact of 15 basis points, with public sector banks being hit harder than private banks.

Stronger liability franchises, including larger public sector banks (Bank of Baroda, Union Bank of India), are preferred in this environment, while looming pension liabilities and portfolio quality pressures are red flags for SBI.

Private sector franchises like HDFC Bank are clear winners here, but come with high valuations. ICICI Bank can be the dark horse if it shows some credit growth after the protracted consolidation. Midcap public sector banks should be best avoided in these circumstances, say analysts.