Banks to go for another round of deposit rate hike: Edelweiss

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Feeling the heat: Banks to go for another round of deposit rate hike Slower deposit mobilization (~10% YTD) coupled with higher inflation and the leader (SBI) setting the bench higher, banks (large and small) have effected another round of deposit rate hike. Signalling pressure on liquidity over the past three months, retail deposits rates have catapulted ~150bps  Lending rate hikes match, but precede the leader Maintaining the earlier trend, hikes in deposit rates by banks came in tandem with increase in lending rates, reflecting the pricing power wielded by banks, their consciousness towards margin protection, and response to RBI’s guidance in monetary policy review. Bucking the trend of the previous cycle, banks are not looking at the leader to react; they are going ahead with lending rate hikes (cumulative: ~140bps increase over six months) , a reflection of expected cost pressures and pricing power (given the strong credit off take) with the banking system. Consequently, the differential between SBI’s benchmark base rate and that of peers has almost doubled (from ~50bps in July 2010 to ~100bps in February 2011)  Relief from extreme liquidity conditions, but rates still firm The banking system has got some relief from extreme conditions, reflecting in the 15-day average net reverse repo coming to a negative INR 878 bn (negative INR 25.3 bn on February 4, 2011) from a high of INR 1.7 tn (on December 22, 2010). This is an outcome of the central bank’s liquidity enhancement of OMO of INR 480 bn (post mid quarter policy review of December 2010) and pick up in government spending, resulting in reduction of its cash balances. However, bond yields continue to remain high (10 year GSEC rate at 7.6%) pointing to expectations of a sticky inflationary environment (suggesting further RBI action) and higher government borrowing programme in the next fiscal. CD rates continue to remain at elevated level, inching closer to the 10% mark. Margin dilemma As against our expectations of stable-to-margin decline for Q3FY11, margins surprised positively, expanding ~7bps for private banks and ~10bps for PSU banks (Table 5&6). While private banks benefited equally on account of CD ratio expansion and asset re-pricing benefit, for PSU banks, asset re-pricing explained significant portion of margin expansion. Given the tight liquidity and slow deposit mobilisation, we believe: (a) cost pressures will be more prevalent (across the banking system), but the impact will be disproportionate across banks, affecting relatively weaker franchisees more; (b) with strong pricing power demonstrated by the banking system as credit growth picks up amidst tight liquidity, we expect lending spreads to remain stable in the near to medium term; (c) hit on investment spreads to adversely impact NIMs, more so, with the LDR touching high (75%), leaving limited scope for benefit flowing from asset re-allocation. We maintain our cautious stance on the sector and prefer strong liability franchises like ICICI Bank, Axis Bank, and Bank of Baroda.