Deposit rate cut to up margins but competition on cards

Yesterday three big private sector banks, ICICI, HDFC Bank and Axis Bank, cut their deposit rates. This has been preceded by some of the state-owned banks already cutting their deposit rates over the last couple of weeks, notable among them being State Bank of India.

Explaining the series of rate cuts, Ashish Parthasarthy, HDFC Bank says that liquidity in August improved significantly, both in the system as well as in the balance sheets of individual banks

"We have seen short rates in the market come off. If you look at certificate of deposit (CD) rates, Commercial Paper (CP) rates and August has been a month where the deposit growth has been much stronger than anticipated and credit growth slightly lesser than anticipated," he elaborates.

Parthasarthy stresses that the deposit rate cut will see margin improvement especially in private banks.  Yes Bank is seeing a 15-20 bps improvement in margins over the course of the year.

This, however, will result in competition. Vaibhav Agrawal, Angel Broking is expecting the rate cut to trigger some degree of price competition among PSU banks to garner as much deposits as possible.

Nearly a week after the country's largest bank SBI cut its deposit rates by upto 100 basis points (bps), ICICI Bank and HDFC Bank have cut their retail deposit rates by upto 50 basis points across different maturities. The reduction in rates comes at a time when economy is slowing down and credit pick up is getting sluggish. Both ICICI and HDFC

Here is the edited transcript of the interview on CNBC-TV18.

Q: What's the trigger for this rate cut, is it that not many people are taking loans?

Parthasarthy: There are two-three factors, if you see month of August has seen much better liquidity. We have seen short rates in the markets come off. If you look at CD rates, CP rates and yes August has been a month where the deposit growth has been much stronger than anticipated and credit growth slightly lesser than anticipated. So all this put together has eased liquidity not only in the market which is a primary liquidity but also liquidity on the balance sheets of banks. So that’s the reason for the rate cuts.

Q: But this August liquidity was always expected. The RBI’s dividend would be paid out, there is one auction less in the early part of September. So this kind of liquidity was expected. Now we will get into advance taxes and we will get into the new borrowing season. Are you expecting liquidity to remain comfortable even in the months to come since you all have taken a slightly long range decision of cutting deposit rates. Would the comfort of liquidity in August be reason enough?

Parthasarthy: Two points, one is primary liquidity which we are talking about is market liquidity and the other issue is of banking balance sheet liquidity, which is the growth of deposits versus credit. Both happened. The growth of deposits has been strong in the month of August. Going forward, this liquidity will become less than what it is today. However, we expect the banking system liquidity or banking balance sheet liquidity to be reasonably comfortable because credit growth has slowed down a bit in the system.

Q: One, what is your estimate for credit growth in FY13, what are you estimating at this point in time vis-à-vis your earlier estimates and two, the deposit rate cuts, would there be a possibility that you would reverse them once the liquidity situation changes?

Parthasarthy: As far as credit growth is concerned, our estimate has been around 17% year on year growth for the system. We are still sticking to that estimate but there is a likelihood of it being lower and may be it would be around 16% by the end of the year if things don’t improve in terms of the investment climate.

If there are new investments, we could easily get to 17%. But, if the investment climate remains where it is today, we would see a lower credit rate growth. As far as reversal of deposit rate is concerned, I look at that as a very unlikely move in the near term because the next move will be down or they may remain here.

There have been liquidity measures by RBI which will keep the system liquidity comfortable in the sense that the overnight rate is anchored because of availability of liquidity from RBI. Given these things and given the lower than anticipated credit growth in the system, I think deposit rate cuts are here to stay for some time.

Q: Do you expect that the industry will follow this up with a base rate cut? We have seen individual sector lending rates getting cut but not the base rate, will that come and is this the first of some more deposit rate cuts according to you?

Parthasarthy: As far as base rates are concerned, some banks including ours did cut base rates during this financial year post the April policy. Of course it takes time for the deposit cost to get reflected into the base rate formula.

Given that these cuts have happened, I think down the road there could be some more base rate cuts either from the banks who have already cut rates or banks who have not moved at all. In the next two months there is a possibility of base rate cut to some extent. As far as loan is concerned, we have seen loan rates come down in specific sectors and that’s likely to be where it is.

Q: Further deposit rates?

Parthasarthy: Further deposit rate cuts I think would then depend on how the policy rate moves. If the policy rates remain unchanged as what they are today, in my opinion, I don't think we will see any major deposit rate cuts going down the line.

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Q: So what exactly is your cost of funds at this point in time and what would your estimate for NIMs or margins be for the remaining part of the fiscal?

Parthasarthy: I don't have the exact number for cost of funds but as far as NIMs are concerned, we have operated in a NIM range of 4-4.3% for the last several years and we will continue to operate in that range. There will be quarter fluctuations but over a period of every financial year, we are going to be in that range. Both lending rates and deposit rates will get adjusted to market conditions and we are quite confident of maintaining that NIM range.

Q: What is your sense now that it is well and truly that the deposit rate cuts have started, should one therefore expect an improvement in margins? How does this cycle invariably impact margins because almost no one has cut their base rates, they have only cut their deposit rates. So is there an immediate improvement in margins?

Agrawal: When it comes to the deposit rate cuts, the reason for it being triggered is not so much because deposit growth has been high but, because credit growth is actually coming down. Clearly in terms of the environment for banks, it is not really very positive right now.

From the margin point of view, we are factoring in stable margins going ahead. But, the relatively smaller banks which have high reliance on wholesale deposits could see a margin improvement. For instance, for some of the private banks such as Yes Bank we are building about a 15-20 bps improvement in margins over the course of the year.

Q: But we have seen several product prices getting cut, auto loans and home loans and in several cases very obviously finance minister even said in parliament that he has asked for these kinds of lower pricing, so do you think that public sector banks would be more under pressure? Basically how are you looking at lending rates, even without a base rate cut are banks actually lending at lower rates to a large part of their customers if not all of them?

Agrawal: This is inevitable because year-to-date, credit growth has been almost negligible and clearly the pipeline also as indicated by banks is quite weak. So as credit growth continues to come down, possibly even below 15% by the end of the year, there will be some degree of price competition between PSU banks to garner certain amount of balance sheet growth.

Q: Do you think that there is more room at this point in time for you to possibly reduce lending rates further in order to boost credit growth in the short-term, particularly for the festive season?

Parthasarthy: As far as our bank is concerned our credit growth has been on track. Purely from our bank's perspective, it is unlikely for that to be the case. However, if the market rate goes down and everyone in the market cuts rates, obviously we will have to move in that direction to maintain our share of the market and reach our targeted rates.

Q: As Mr Agrawal pointed out, the manner in which bankers tell us about the complete lack of demand for loans, the prospect of loan growth going to 15% towards the end of the year cannot be ruled out you think and therefore what can be the impact on yields? Do you think that there is going to be a secular pressure for yields to fall?

Parthasarthy: If that is the state of the economy where credit growth falls to such a low level, it obviously means you are seeing much lower GDP growth than what has been projected so far. In such a scenario, you obviously see downward pressure on yields in the long-term.

Q: But what is your guess, is that your base case that things could snowball into yields falling towards 8% or lower?

Parthasarthy: That is not our base case, our base case projections for GDP is 5.5% for the year, which is low but not extremely low. We are not expecting a huge fall in inflation. Inflation will remain where it is. We are slightly optimistic on growth towards the end of the financial year. If at all we are not as pessimistic to project a 15% credit, we are saying it will be around 16-17%, that ballpark range. Given that, we expect yields to be steady; we don’t see rise in bond yields or a sharp fall in bond yields. We expect them to be rangebound. Although 8% cannot be ruled out but we expect the range to be more like 8.10 to 8.40% during the rest of the financial year.

Q: Yes Bank in this particular environment is your top pick. Give us a sense about other private banks, how exactly would you be placed on the likes of Axis and ICICI and what would your top picks from PSU space will be?

Agrawal: Within the private banks, ICICI and Axis from a valuation standpoint as well as earnings growth clearly look better than the PSU pack. They still remain a buy for us. Within the PSU pack we are increasingly cautious because we expect NPA pressures to continue for a prolonged period. We are quite selective within the PSU space. Within that I think what an investor can do is really bottom fishing and value buying and from that standpoint we like Punjab National Bank and Union Bank in the PSU pack.