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Will these banks yet again 'sacrifice' NIMs? - Views on News from Equitymaster

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Will these banks yet again 'sacrifice' NIMs?

Jul 5, 2013

The Indian banking sector is reeling under the pressures of low credit growth with poor assetquality. While the bad loans have resulted in asset quality woes, the laggard credit and deposit growths have been particularly worrying. In this backdrop, the Finance Minister has urged the lenders to reduce their lending rates and pass on the benefits to the end consumers. Not that all banks are prompt in paying heed to such mandate. But for a few it is a question of when as against whether to do so.

Why is the government insisting on rate cut?

The Reserve Bank of India (RBI) has reduced the repo rate or the short-term lending rate by 1.25% since January 2012. But the lenders have passed on only 0.30% to consumers. When the regulator calibrates its short-term lending rates, it is expected that the monetary transmission (passing on of rate cut benefits) should take place with banks reviewing their lending rates too. Moreso, the Finance Ministry believes that the banks should be increasing lending to the productive sectors of the economy to prop up growth and investments. The economic growth rate has been sagging at decade lows of 5% in 2012-13 and credit-offtake has remained subdued. The credit growth was seen down to 15.6% in 2012-13 from 17.8% a year before.

The government has been particularly keen on monetary policy rate transmission by the lenders. However, lenders are facing their own set of issues. Bankers do not see any headroom to cut either lending or deposit rates despite the repo rate cuts by RBI on account of tight liquidity conditions that have kept the cost of funds elevated. The higher inflationary levels have ensured higher costs of deposits. Any further rate reduction would take a toll on the banks' net interest margins (NIMs). Moreover, the scope of lending rate cut gets difficult further with the lagged deposit growth in the system that has not improved significantly. The deposit growth has been hovering around 14% levels for major part of 2012-13. This restricts banks to reduce deposit rates and bring down their costs of funds. While both SBI and Bank of India (BoI), for instance, have already tinkered with cut in deposit rates to balance their asset-liability portfolio; flight of deposits forced them to reverse the rate cuts.

While few banks have responded to the push, others have remained reluctant. The country' s largest lender, State bank of India (SBI), for instance, preferred to maintain a status-quo since the base rate of the bank already stands lowest in the industry at 9.7%. This leaves very little headroom for transmission. The average base rate of all other banks fall in the range of 10.2%-10.25% and are expected to re-align their base rates with that of SBI.

Source: Banks' presentations

Additionally...the rate cut may worsen asset quality woes!

Further forcing banks to reduce lending rates and clear stalled projects would only add to the rising non-performing assets (NPAs) and in turn hurt profitability. The NPAs for PSU banks are nearly twice the size of NPAs of the private sector lenders, primarily due to exposure to unviable public sector projects. While the private banks shy away from lending to the long-gestation projects and the government projects, PSU banks are compelled to do so. Therefore, the renewed push by Ministry to cut lending rates would only worsen the situation.

The PSU banks, therefore have the maximum likelihood of facing the brunt arising out of the rate cut coercion. Private lenders may relatively hedged given their independence in pricing loans according to the inflation scenario and risks to asset quality.

Shweta Daptardar-Mane

Shweta Daptardar-Mane, has an MBA (Finance) degree and over five years of equity research experience. She passionately tracks the Banking and Finance industry and follows the macro developments in the economy, particularly the central bank monetary policy. She is deeply inspired by not only Buffett's investment acumen, but also by his infectiously charismatic, down-to-earth persona. Shweta is the contributor to our large cap franchise, StockSelect.


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