Motilal Oswal: INDIAN BANKING: Deposits rates rising; Proactive lending rate hike to protect margins

INDIAN BANKING: Deposits rates rising; Proactive lending rate hike to protect margins

SBI and PNB have increased deposit rates by 25-100bp in certain maturities. At the same time, some banks have announced their base rate as part of a Mandatory Quarterly Review. While SBI has maintained its base rate at 7.5%, others have increased rates by 25-50bp. Our view on change in deposit rate and base rate:

-          As deposit growth continues to lag loan growth and inflation moderation takes time, we expect deposits rates to continue to increase in 2HFY11. We expect other PSU and private banks to also increase deposit rates soon.

-          Incremental CD ratio is at 100%, leaving enough pricing power with banks to raise lending rates. Banks have already raised PLR by 50bp in 2QFY11 (impacting existing loans), and now they have increased base rate by 50bp (impacting incremental loans).

-          In this cycle, banks have been aggressive in hiking lending rates as compared to the earlier cycles, where they did so with a lag of 6-8 months.

-          Cost of funds is expected to rise, led by sharp increase in borrowing cost - wholesale rates are up 250bp YTD, retail up 100-150bp YTD. However, early transmission of rising cost to funds will lead to only marginal decline in margins (given time lag between deposit and lending rate hike). We expect NIMs to decline marginally in 2HFY11 vs 1HFY11. However, on a blended basis, FY11 margins for state owned banks are likely to be higher than in FY10, translating in to strong NII growth.

-          Banks where there is lower repricing of deposits in FY11, have high CASA growth and the ability to pass on the increased cost of funds will report superior relative performance.

Change in Base Rate over previous quarter (%)                 Change in PLR YTD (bp)                                                            Change in bulk deposit rates (CoD)

            

Trend in SBI retail term deposit rates (%)

Valuation and view

-          Despite strong outperformance, we maintain our positive stance on the sector. Loan growth is the key for strong core operating performance to continue in 2HFY11.

-          We prefer selective buying and like banks with a strong core deposit franchise, higher tier-1 capital and high provision coverage ratio.

-          We continue to prefer SBI, PNB, BoB and Union Bank in the current environment. Among private banks we like ICICI Bank (improving liability profile) and Yes Bank (ability to pass on cost, 94% of loans linked to PLR). While HDFC Bank enjoys high CASA ratio and high-yielding fixed retail loans, we believe that the stock is fully valued at the current price.