Banking: IIFL: Q3 FY11 Sector Preview

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Banking : IIFL: Q3 FY11 Sector Preview

 Liquidity significantly tightened during the quarter with banks’ daily average borrowing from RBI under

LAF increasing to Rs1.2tn in December as compared to Rs250bn in September. The short-term rates

(call rates and 3m/6m CPs) spiked by +200bps between September-December 2010.

 In its second quarter monetary policy review in November, RBI raised key policy rates by 25bps to

anchor inflationary expectations while in the latest mid-quarter review in December, the central bank

kept rates unchanged and focused more on increasing liquidity in the system.

 System credit growth has improved significantly on revival in private investments - Qoq loan growth in

Q3 at 6.4% v/s 3.4 in Q2. Yoy credit growth momentum has increased to 23.7% and Ytd credit

expansion stands at 12.3%. To achieve RBI’s full-year credit growth target of 20% yoy, the system

requires Rs2.5tn credit expansion in Q4 (6.8% qoq growth). We expect FY11 credit growth target to

be achieved driven by further acceleration in corporate credit demand and banks rushing to meet their

PSL target (a seasonal tailwind).

 On the flipside, deposits have been growing at muted pace. In Q3, it grew by just 2% qoq. Both, yoy

growth momentum and YTD accretion in deposits have been significantly behind advances at 14.7%

and 7% respectively. To achieve RBI’s full-year deposit growth target of 18% yoy, the system

requires Rs5tn mobilization in Q4 (10.3% qoq growth). Though banks are raising deposit rates quickly

to capitalize on the improving credit demand, we think annual deposit growth would be lower at near

15%. Due to high inflation, retail customers have been preferring higher return yielding assets over

deposits.

 We expect 4-7% qoq loan growth for the banks under our coverage. In-line with the system, deposit

growth could be lower than advances thereby improving the C/D ratio on sequential basis. In Q4, the

C/D ratio is likely to come-off though.

 With more frequent and significant deposit rate hikes than lending rate hikes during the past five

months, we expect NIMs (currently at multi-quarter high for many banks) to contract by 10-30bps
qoq in Q3. A probable decline in CASA due to substantial increase in term deposit rates (as witnessed
during Q2 FY09-Q1 FY10) would also increase cost of deposits on sequential basis. We expect NII
growth to be in the range of 25-30% yoy.
 The 25-30bps increase in the G-Sec yields could mean sequentially lower treasury income. However,
the growth in the core fee income is likely to be strong driven by robust loan growth. The C/I ratio
could deteriorate qoq on account of continued investments in network expansion and flattish NII
growth.
 Asset quality of PSU banks may further show some strain while that of private banks would remain
stable. Loan-loss provisioning by SBI and PNB is expected to be significantly higher thereby
depressing profit growth.