Edelweiss: Banking sector update- base finally moves

In response to hike in deposit rates over June-September 2010, banks across the board have started raising their base rates (the new benchmark) after increasing PLR in the first instance. So far, amongst large banks, ICICI Bank, Axis Bank, and HDFC Bank have raised their base rates by 25bps each, while Punjab National Bank (PNB) and Bank of Baroda (BoB) raised it by 50bps; however, State Bank of India (SBI) kept its base rate unchanged.

In the current cycle: (a) banks have raised both deposit and lending rates in tandem against a lag last time around; and (b) PSU banks have been quicker in response, not waiting for the leader (SBI) to react. This reinforces our belief that monetary transmission is more effective via base rate and the banking system still has pricing power—evidence of resilience of strong margin performance. 

·         Structural positive for PSU banks: PSU banks being more acquiescent to moral suasion from policy makers increase PLR less readily than private banks. However, the objective methodology for determining base rate is now playing out as these banks are raising base rates much earlier than the PLR hike in the previous cycle—a structural positive for PSU banks.

·         Risk of disintermediation: Though disintermediation is set to rise as top rated corporates are likely to opt more for commercial papers (CP), we expect limited migration as 3M-CP rates over the past three months have picked up by ~150-200bps, gyrating to the liquidity tightness and are currently hovering at ~7.5%, paring down the differential significantly. Also, given that the CP market is not very deep (limited appetite below P1/P2+ rated corporate), we believe mid size corporates will continue to depend on the banking system.

·         Wielding pricing power: The fact that small PSU banks like Indian Overseas Bank (IOB) and Andhra Bank (ANDBK) raised their base rates despite SBI keeping it unchanged is a testimony of managements’ confidence in their ability to push higher costs to the borrower, reflecting pricing power in the system. This, in turn, reflects the systems’ ability to maintain NIMs at current level.