India Financial Services Can Banks Cut Rates? No.- Morgan Stanley Research,

India Financial Services
Can Banks Cut Rates? No.
Given RBI’s rate cuts investors have been expecting
banks to cut deposit rates. This view/hope has been
helped by the continued decline in WPI inflation.
Our view has been that banks will struggle to cut
deposit rates (and hence base rates) by more than
25-50 bps and post SBI numbers, even that looks
unlikely.
The problem with lack of transmission of low rates
in India has been deposits – The banking system LD
ratio has stayed sticky at close to historically high levels
of 77-78%. While loan growth has slowed to around 15%
YoY, deposit growth has been even weaker at closer to
13%. The key reason, in our view, is the fact that real
deposit rates (adjusted for CPI) are meaningfully
negative. Banks will not get pick up in deposit growth
unless real rates rise.
SBI indicated massive deposit competition ahead –
The bank’s LD ratio was even higher than the system at
82%. This explains the deposit rate hike by the bank in
March 2013. Management said that for F14 it is targeting
loan and deposit growth between 20-25%. With system
growth likely to be between 12-14%, this implies that SBI
will aggressively compete for deposits. Also given that
the current Chairman retires in September, he may want
to follow on this fairly aggressive guidance. If SBI does
not cut deposit rates, others will be unable to, given
SBI’s size and positioning.
The 2008 rate cut cycle was very different from the
current one – A number of market participants are
focused on bond yield and impact on SOE banks. Our
view is that, yield decline will help, but it’s a band-aid
solution. To get out of the asset quality trap that these
banks have got into, cost of capital needs to drop
sharply – that’s not happening.
This is unlike the 2008/2009 cycle. By August 2009, LD
ratio for banks had declined to 69%, allowing banks to
cut deposit rates by as much as 400 bps and GDP
growth also rebounded. This helped the banks. This is
unlikely to recur in F2014.

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The risk for banks is that they are forced to cut lending
rates (or raise deposit rates) – Since banks have migrated to
a base rate system, lending rates are formulaically linked to
deposit rates. Hence, the risk of lending rate cuts without
deposit rate cuts is low. But if banks do cut the base rate
without cutting deposit rates, NIMs will come under pressure at
a time when provisions remain sticky at high levels and wage
hikes are hitting earnings.
The market has been bullish on banks with weaker
balance sheets assuming a rate cut cycle – Unless rates are
cut meaningfully or growth picks up sharply, asset quality
concerns will remain high. In this backdrop quality names will
continue to outperform over any longer term period. We have
an UW on SOE banks (ex BoB which is EW) and OW on retail
lenders (HDFC Bank, HDFC, Shriram, Indusind and LICHF),
ICICI Bank and Yes Bank. The balance sheet stress at SOE
banks implies that private banks are well placed to gain big
market share – which will keep their growth much stronger.
What will make us bullish would be sharp improvement in
system liquidity driving up deposit growth and creating enough
room for banks to cut rates aggressively. This will help banks
reduce asset quality problems and start growing loans again