Banks: Challenging environment

Rising deposit rates are likely to drag net interest margins in the quarter ended December 2010.

High credit growth is expected to drive banks’ core operational income (net interest income) in the quarter ended December 2010, but rising deposit costs will lower interest spreads, say analysts. Tight liquidity conditions are expected to hurt margins of both banks and non-banking finance companies (NBFCs) that rely mainly on bulk funds.

Lower non-interest income growth, given a quiet quarter on the treasury income side, alongside negligible relief on loan-loss provisioning for public sector banks (compared to the previous quarter), is expected to drag down net profit growth to 16 per cent year-on-year, reckon analysts. Private sector banks, however, are expected to see lower slippages and, consequently, lower provisioning on a sequential basis.

Given that most banks raised base rates and prime lending rates last month, analysts expect the impact on net interest margins to be cushioned. Although, a Kotak Institutional report says banks may see margins fall by 5-10 basis points. HDFC and Shriram Transport are expected to benefit from asset repricing, but other NBFCs will see margins contract on a year-on-year basis due to tight liquidity, which has pushed money market rates up.

Portfolio quality issues continue to haunt public sector banks, which are expected to see higher slippages after the change to the system-based non-performing loan recognition. While the asset quality pressure is expected from small and medium enterprises, analysts expect some cushion from higher recoveries. State Bank of India and Union Bank are key banks to monitor in terms of asset quality.

The Bombay Stock Exchange Bankex has underperformed the Sensex by over 10 per cent on an average in the last one month, weighed down by macroeconomic concerns, including high inflation and likelihood of another rate rise in the policy review this month.

A Citibank research report says the outlook for the sector remains positive in the medium term, parallelling robust economic growth, and the correction provides an attractive opportunity to invest in bank stocks with strong deposit franchises.