Deposit-rate cuts may not be that steep

Lower interest on small saving schemes to give some room for reduction; bigger hit after MCLR

The government's move to cut interest rates on small saving schemes by 40 to 130 basis points is a positive for banks. The rate differential between bank deposits and small saving schemes will reduce (in some cases, the gap was as high as 170 basis points, or bps). The move will also allow banks to cut  deposit rates across select maturities, thereby lowering the costs. "State Bank of India (SBI)'s one-year term deposit rate is 7.25 per cent, higher than the 7.1 per cent rate on post office one-year deposit, providing banks headroom for further cuts," analysts at PhillipCapital said.

But, the net interest margins of banks might not improve much, as they will likely cut lending rates after  implementation of the MCLR (marginal cost of funds-based lending rate) from April 1.

Reduced rates will apply only to new inflows in savings schemes, as well as bank deposits, if banks cut rates. Existing bank deposits will continue with past rates until renewed on maturity at new rates, thereby limiting the margin gains.

Positively, analysts believe after implementation of MCLR, corporate demand for short-term funds such as commercial papers might shift to banks and aid their loan growth, as the interest rate differential between these funding avenues will narrow.

Vaibhav Agrawal, analyst at Angel Broking, expects 100-bp cut in banks' base rate over FY17. Some analysts remain more cautious. Suresh Ganapathy, analyst at Macquarie Capital, says lending and deposit rate cuts will be capped at 25 bps in the medium term. "Considering only 35 per cent of small savings schemes will see an effective rate cut of 90 bps, the effective reduction is only 30 bps. Further, 70 per cent of bank deposits come in the maturity bracket where small savings schemes rates have been cut," he says.

Banks' ability to cut base rates is also limited by the near-term requirement of provisions towards bad and doubtful loans. Though lower interest rates aid loan growth, a sustained pick-up in new capital expenditure is essential for boosting credit demand, more likely to see a gradual pick-up. Non-banking financial companies (NBFCs) stand to gain from the development via lower borrowing costs.

Against this backdrop, it is not surprising that banking and NBFC stocks grew a modest one to three per cent on Monday.