Revaluation of liabilities will be a challenge for banks

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Banks, relative to other sectors, have been vulnerable to many market cycles, and Indian lenders have been reasonably resilient over the past two decades. Although each cycle may seem similar, they are far from identical.

Therefore, if it is necessary to draw a parallel with the taper tantrum of 2013, the situation is different today.

For starters, banks were prepared for rate hikes in FY23, even though the quantum took them by surprise. Second, in terms of balance sheet strength, with most NPLs being well provisioned and banks having at least a quarter of the provisioning cost as a buffer, they are better placed to weather rising rates.

Cost benefit to shrink

But here’s the catch. The relevance of deposits in relation to banks’ overall liabilities has increased considerably compared to 2013. They now represent 80 to 85% of liabilities (excluding equity, reserves and surplus) compared to 70% a decade ago, when reliance on bonds was much higher. Thus, with part of the liabilities tied to low-cost options, banks had the latitude to raise deposit rates to provide liquidity, without incurring an immediate impact on the cost of funds.

This time around, the cost of funds is at an all-time low of 5.5% or less for the cream of private and public sector banks, and the question is how well they can reprice it without jeopardizing their profitability. (or their net interest margin). In fact, what really boosted bank earnings in FY21 and FY22 was the low cost of funds. Therefore, even though interest income increased by less than 10% for the 10 largest banks, a significant reduction in interest expenses contributed to a sustained growth in net interest income during the year. 21-22. In FY23, the cost-benefit ratio may decline.

Impact on loans

For example, banks have already seen the repo rate increase by 90 basis points since May 4. To partially hedge their profitability, banks passed on almost entirely the 40 basis points of the first rate hike, and may even pass on the 50 basis point hike that occurred today. .

The transmission of the first phase of rate hikes is not viewed negatively from a credit demand perspective, as borrowers generally anticipate their purchases or take credit in anticipation of further hikes. While in the upcoming June quarter NIMs may not be hit too hard, investors should keep an eye on bank loan growth projections. Relentless inflation at the RBI’s upper tolerance limit of 6% may pose a threat to demand.

NIM reduction

More importantly, the wiggle room of a low cost of funds can shrink and a higher cost of funds eat away at NIMs. This could play out from the September FY23 quarter. The transmission of repo rates will affect the assets and liabilities of banks’ balance sheets.

While active-side transmission was supported, passive-side transmission was limited. For example, while SBI raised its bulk deposit rates (₹2 crore and above) by 40-90 basis points in May, retail deposit rates increased by 10-15 basis points at best. Unlike the immediate revaluation of loans, deposits have not yet been revalued.

With the substantial reduction in excess liquidity, banks may once again have to turn to depositors for growth money. This time it won’t be cheap. Bankers believe that the 2016-2018 situation of luring deposits (including savings accounts) at attractive rates could happen again. Given that NIMs for most banks have risen by 100-150 basis points since 2017 (to over 4% for most private banks and over 3% for PSBs), reducing some easing in profitability could be the solution to support growth. “With inflation and cost pressures coming at the same time, for growth to maintain FY22 levels, ditching NIMs a bit isn’t a bad idea,” the CEO said. a private bank.

Clearly, while Fiscal 23 may have started on a clean and strong note for banks, challenges persist.

Published on

June 08, 2022

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