Banks: Repo rate blues

The BSE Bank has been battered losing 39 per cent since the start of 2008 compared with a 25 per cent fall for the Sensex.

The outlook for the sector has been rather bleak with the market concerned that high inflation will keep interest rates high and that would make borrowers, mainly retail customers, hesitate to take loans.

With the central bank having raised the repo rate""the rate at which banks borrow from the central bank""- by 25 per cent, it is clearly signalling higher interest rate.

As such, it seems unlikely that banks will not increase their lending rates by about 25-50 basis points, though this may not happen immediately. More important, if liquidity is short, they will need to raise deposit rates which will push up borrowing costs, especially for tenures of two years and above.

Unless banks can pass on the higher cost of money to quality borrowers, spreads are sure to be under pressure. While credit growth may have been reasonably strong in March and April, some of it is due to higher borrowings made to purchase crude at higher prices.

There are also concerns on loan delinquencies especially in retail, agricultural and SME portfolios. Also, fee incomes are likely to decelerate in FY09 because of a weak capital market and lower revenues from derivatives products. Thus spreads could be under pressure this year.

Valuations for public sector banks are now very cheap with most of them trading in the range of 0.6 times ""1 time FY09 estimated book value.

At Rs 1310, State Bank trades at just over 1 time forward book while ICICI Bank at Rs 742, trades at 1.6 times book and HDFC Bank at Rs 1185, trades at 3 times FY09 book value.

However, the sentiment is so weak that it might not be a bad idea to allow stocks to drift further before bottomfishing.