Indian Financials:: Lower reserve norms, a possibility ::CLSA

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Lower reserve norms, a possibility
RBI governor recently mentioned that reserve requirement in India needs
to come down gradually. Interestingly it comes at a time when globally
regulators are pushing for tighter regulatory requirements. Regulatory
requirements in India (reserve requirements, risk weights, accounting
norms) are more conservative than most globally accepted norms
(including Basel) and hence offer scope to be relaxed over a period of
time. The medium to long term story for Indian banks remains strong,
with multiple drivers for growth and profitability; signals on relaxation of
statutory requirements should be positive catalysts for bank stocks.
RBI governor says reserve requirement needs to come down
q Speaking at a conference, the RBI Governor mentioned that the minimum
mandatory amount of deposits that banks need to set aside to invest in
government bonds (Statutory Liquidity Ratio – SLR) need to come down gradually.
q The SLR currently stands at 24% of liabilities and together with the Cash Reserve
Ratio (CRR) of 6%, the total reserve requirement for Indian banks is 30%, well
above most markets globally and above the proposed requirements under new
Basel.
q While the governor is also possibly hinting at a need to reduce the fiscal deficit, we
believe the requirement to reduce the SLR is more structural in nature given the
rising demand-supply mismatch.
q With a target to bring down fiscal deficit from 4.6% in FY12BE to 3.5% by FY14BE,
the government plans to bring down the supply of government paper.
q At the same time, demand from non-banking players (insurance companies, foreign
investors) is rising, resulting in lower pressure on banks to subscribe to G-Secs.
q This, to some extent, is arguably responsible for the depressed 10-year G-Sec
yields (in last one year while 1 year G-Sec yields have risen by 140bps, the 10 year
G-Sec yields have risen by only 20bps).
Shift towards optimal asset-mix could boost profitability
q At present, nearly half of an Indian banks’ assets are in regulated category (see
figure 6) – SLR, CRR, priority sector targets etc.
q We believe over a longer period (5-10 years) these requirements will come down –
either by the stated percentage being lowered or by widening of the definition.
q Such a move will improve the ratio of optimal assets in total assets for the banks –
positive for margins, fees and overall RoA.
q Additionally, the risk weights in India on certain category of assets (primarily
mortgages) are higher than Basel norms (figure 8) and a reduction in these risk
weights would increase the ability of banks to leverage– positive for RoE.
q Interestingly at a time when global regulators are pushing for tighter regulatory
requirements for banks, we believe Indian banks are amongst the few that could
possibly see an easing regulatory framework.
Possibly a re-rating catalyst? Case Study on US banks
q A look at the history of US banks suggests that this could arguably act as a rerating
catalyst for Indian banks over the longer run.
q Between 1994 to 2001 the proportion of treasury holding in total assets for US
banks declined from 21% to 13% and in this period the US bank rallied 3x, out
performing the market.
q We believe G-sec holdings as a % of total assets for Indian banks are directionally
headed in the same direction, may be not to the same magnitude. Lower reserve
requirements would be a boost to profitability and valuations.