Banking - Rate cut: NIMble buffer, asset quality to do the trick; sector update : Edelweiss PDF link

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Over the past week, banks have responded to RBI’s 50bps rate cut by reducing their base rate by 25bps and deposit rates by 25-50bps. We believe, even if banks take 50bps cut driven by RBI/GoI moral suasion, the fallout in terms of improving asset quality will help negate the impact of NIM decline on valuation multiples. Further, NIMs for most banks are up 10-40bps since Q1FY12 and are at cyclical highs, offering the required cushion for NIM moderation. We believe banks are cautious with rate cuts even while 125bps CRR cut has helped ~10bps on the CoF, due to lagging deposit accretion and the liquidity conundrum. We maintain our preference for private banks and have incrementally turned positive on BOB and OBC in the PSU space in light of attractive valuations. Top picks: Axis Bank, ICICI Bank and Federal bank.

RBI’s bold move - To bring down lending rates

RBI’s move to cut benchmark rates by 50bps took everyone by surprise. What further added to the perplexity was the maintenance of cautious stance on inflation making a comeback again – the main driver of aggressive rate hikes. We read RBI’s action as a strong directive for banks to reduce lending rates to oil the economy’s growth engine. Already, we have seen banks cut lending rates by 25bps. SBI, however, has guided for product specific rate cuts rather than a base rate cut which is still 50-75bps lower than other PSU banks.

NIMs comfortable; adequate buffer for moderation

Our analysis suggests that over the past 2-3 quarters, banks have seen noteworthy improvement in NIMs. While deposit rates were unchanged post March 2011, the upward move in lending rates continued until September 2011, concomitant with RBI’s rate hikes. The surplus NIM built-up will enable banks to take the overall 50bps rate cut in over the next 1-2 months. Though not as immediate as the CRR cut, easing of wholesale deposit rates will also comfort the CoF, while reprising of term deposits downwards will be a medium-term phenomenon.

The rationale behind just a 25bps cut is clearly to protect NIMs, as though wholesale rates have declined, the current phenomenon might be coloured by the seasonal easing of liquidity in April. Also, since the next cuts are not happening in a hurry, banks have time to give effect to RBI’s directive in steps, thereby, calibrating the NIM decline. 

Stabilising asset quality to negate impact of NIM decline

Last year, asset quality has been the focus area with performers amply rewarded by markets while laggards continue to underperform. Going forward, we factor in slippage run rate to abate even though restructuring of identified corporate and SEB accounts will continue. Our belief on gradual improvement in asset quality comes from relief that will accrue due to rate cuts, particularly to SMEs. However, this will be a long drawn process as economic revival (key determinant of asset quality) will be gradual.

Banking - Rate cut: NIMble buffer, asset quality to do the trick; sector update

Regards,