RBI Monetary Policy – Impact on India Financials

Visit http://indiaer.blogspot.com/ for complete details �� ��


India Financial Services
RBI Monetary Policy – Impact
on India Financials


Quick Comment: The Reserve Bank of India has
announced its second quarter review of monetary
policy.
The key measures from a financial sector perspective:
1) Policy rates raised by 25 bps, further rate hikes in
immediate future unlikely: The RBI has raised policy
rates (repo and reverse repo rates) by 25 bps (to 6% and
5.25%, respectively). The cash reserve ratio (CRR) has
been left unchanged at 6%.
However, it mentioned that “the likelihood of further rate
actions in the immediate future is relatively low”. Our
economics team now expects RBI to hike policy rate by
25 bps by March 2011, compared with 50 bps expected
earlier. This, coupled with QE2 implementation, should
help anchor funding cost pressures benefiting asset
aggregators in India (see “Asset Aggregators: Heading
for a Sweet Spot” dated October 11, 2010 for details).


2) Tighter norms on mortgage loans: The RBI has
taken three measures with regards to mortgage loans in
India – increasing general provisioning on teaser rate
loans, higher risk weights on high ticket loans and
capping mortgage LTVs at 80%.
We view all these measures extremely prudent in nature
wherein the RBI has targeted the potentially riskier
products like teaser rate loans. It will likely rationalize the
competitive intensity and reduce the risk of a sharp
slowdown in the future (akin to the measures that it took
with regards to securitization of loans in April 2006).
a) Increased general provisioning requirement on
“teaser” rate loans from 0.4% previously to 2.0% (i.e.
for every Rs. 100 of loans, banks will now have to set
aside Rs. 2 as provisions, which will have to be taken
through the P&L).
- What are teaser rate loans? Although the exact

definition of teaser rate schemes hasn’t been clarified, the RBI
has mentioned that it is concerned about the risks arising from
“loans are offered at a comparatively lower rate of interest in
the first few years, after which rates are reset at higher rates."
These teaser rate loans have gained in popularity because of
the low fixed interest rates that are being offered in the initial
years.
- Is the increase retrospective? While the policy document was
unclear, the RBI governor later clarified that the increased
general provisioning requirement will be applicable
retrospectively (i.e. on the existing stock of loans disbursed as
well).
- Does it apply to housing finance companies (HFCs) as well?
The RBI has clarified that once it releases its detailed
guidelines, the National Housing Board will come out with
similar guidelines. Hence, the increased general provisioning
requirement will likely apply to both HFCs (like HDFC and
LICHF) and banks.
- What is the financial impact? We need to wait for the final
guidelines before we get the exact impact of teaser loans – for
instance, the definition of teaser rate loans is still unclear and
regulators could give the companies some time to achieve the
provisioning levels.
Our approximate computations suggest that the pre-tax profit
impact of the above on our coverage stocks would be about Rs.
1.9 bn (17% of F2011e PBT) for LICHF, Rs. 3.7 bn (~8% of
PBT for HDFC) and less than 1.5% of PBT for SBI and ICICI
Bank and even lower for other banks.
Further, companies have access to excess general provisions
they are carrying, which will potentially be used to offset the
impact. For instance, LICHF has Rs. 1 bn of excess provisions
while HDFC has Rs. 3.9 bn. Hence, the net impact
(assuming that they use these excess provisions) could
be 8% of PBT for LICHF and zero for HDFC. Even banks
like ICICI Bank have access to the excess provisions.
The other uncertainty is what happens to these excess
provisions once loans move from fixed to floating. Logically, if
the borrower is servicing the loan (for say 1 year) even after the
change in rates to floating rate, then the excess provision
should be rolled back. However, the policy was silent on this.
We need to wait for detailed guidelines.


- Will this move impact industry growth / competition? In our
view, the teaser rate scheme will likely be discontinued or
pursued with less intensity by the banks/HFCs following the
increase in general provisions.
Given that the teaser rate schemes have been a key driver to
growth – we will have to wait and watch to see the eventual
impact on growth (our property team believes that this will have
a marginal impact on the property sector – since they believe
that in the current stage of the cycle, the key determinant of
demand is affordability (income) and property prices and not
mortgage rates).

In our view, the positive for HDFC and LICHF is that the
competitive intensity from banks (namely SBI and other PSU
banks) in the form of fixed-floating rate loans will likely reduce.
However, LICHF could be under pressure in the near term
owing to the hit on account of increased provision requirement.
We maintain our OW call on the stock since the key catalyst to
the stock – loan growth – is likely to remain strong and
competitive pressures, though present, are unlikely to intensify.
b) Increase in risk weights on high value loans from 100%
to 125%: For loans greater than Rs. 7.5 mn in size -- the RBI
has increased the risk weight from 100% previously to 125%. In
our view, this is unlikely to have a material impact on capital

adequacy /profitability since it is a relative small proportion of
incremental disbursements.
c) Capping of mortgage loan-to-value (LTVs) at 80%:
Previously, there was no cap on LTVs. This again will likely
have limited impact on growth / profitability since most loans in
India were made at lower LTVs. The key segment that can be
impacted by this move will be the 10/90 product, which had
gained prominence for high ticket loans (10% downpayment in
initial years and balance payment on possession of the
apartment – once the construction is completed).
3) Capital adequacy norms for financial conglomerates:
For financial conglomerates, the RBI has decided to implement
the capital adequacy recommendations of the Internal Group
on Supervision of Financial Conglomerates (FCs). Under these
recommendations, investments by FCs that exceed 20% of the
paid up equity of other financial entities (including insurance
companies) will have to be deducted from capital (50% from
Tier I and 50% from Tier II capital) when these are not
consolidated for purposes of capital. We believe these norms
could potentially impact HDFC. Although it is not directly
applicable to them as of now (since they are regulated by the
National Housing Board and not the RBI) – there is a chance
that NHB may implement the above.
Currently, HDFC’s direct investments in HDFC Bank are not
deducted from their Tier I while their other investments in
subsidiaries are 100% deducted from Tier I (in excess of 10%
of HDFC’s BV). If these new norms are implemented for HDFC,
their investment of Rs. 55 bn in HDFC Bank will get deducted
from their Tier I.
At the same time, we think it unlikely that HDFC has to adjust
capital for HDFC Bank investment and still take 100% hit on
other investments. We assume 50% deduction for other
investments (Rs. 22 bn). The management has indicated
that the net impact of this move on Tier I is likely to be -90
bps. We highlight that it is still not clear whether the FC
norms would apply to HDFC (and also that even after
factoring in the potential reduction, their Tier I would still
be very strong at 12.1%).
4) Savings rate deregulation: The interest rate paid on
savings deposits is still regulated rate in India (fixed at 3.5%
since March 2003). The RBI has indicated that it is going to
release a paper to the potential impact of deregulation of this
rate by end-December 2010.
5) Priority sector lending to MFIs: Currently, bank lending to
microfinance institutions qualifies as priority sector lending –
there has been some debate in the media on the merit of this
status given that the MFIs have been on-lending this at much
higher rates.
The RBI has indicated that it will be taking a final view on the
priority sector status given to bank lending to micro finance
institutions after the Malegam Sub-Committee (constituted to
look into these entities functioning) submits its report
end-January 2011.
6) Bank investment in non-financial companies: The RBI is
going to separately issue guidelines that will stipulate
limits/regulate bank investments in non-finance companies.
7) New bank licenses: The RBI has indicated that it will be
releasing draft guidelines for licensing of new banks by
end-January 2011 for public comments. This follows its initial
announcement in this regard in April 2010 and the discussion
paper that they had released in August 2010 (See our note
“RBI Releases Discussion Paper on New Bank Licences”
dated August 12, 2010 for details).
8) Implementation of advances approaches under Basel II
approach: Guidelines for the advanced measurement
approach for measurement of operational risk will be finalized
by April 2010. Further, the RBI has indicated that guidelines for
internal rating based approach for credit risk are under
preparation (no timeline has been indicated as yet).