Banking & Finance Theme 3: No signs of deposit competition ebbing; expect divergent margin outcomes

11 Jan 2024 , 11:24 AM

This is Part 3 (focused on deposit competition & margins) of a 4 part-series (Part 1 & Part 2) where analysts of IIFL Capital Services discuss outlook for banks’ key earning drivers. With tight system liquidity and alltime high LDR, deposit competition has aggravated and is reflected in: (1) Recent rate hikes in bulk and short-tenure TDs. (2) Select mid-sized Private banks’ peak savings ROI now higher than larger banks’ peak TD rates. (3) Banks augmenting funds by stepping up CD and bond issuances. While loan yields are likely to increase only by 10-15 bps, analysts of IIFL Capital Services deposit re-pricing framework shows cost of deposit to increase further by 5-50 bps. Analysts of IIFL Capital Services thus expect divergent near-term margin outcomes – stable for HDFC, IIB, Federal Bank, RBL and BOB; higher contraction for ICICI and Kotak; and lower contraction for Axis and SBI. Analysts of IIFL Capital Services sector top picks are Axis, IIB and HDFC Bank. 

No signs of deposit competition ebbing: 

Banking system liquidity deficit is the highest in the past five years, and has not improved despite the withdrawal of ICRR from Oct-23. As a result the banks’ interbank borrowing has risen and the overnight rates have increased beyond the RBI’s MSF rate of 6.75% vis-à-vis repo rate of 6.5%. To augment funds, banks have significantly stepped up certificate of deposits (Rs5.5 trn in FYTD24, which is 2.5x of the last four year avg.) and bond issuances (mainly by the PSU banks). Deposit competition has become irrational with SA deposit interest rate offered by select mid-size private banks now higher than the peak TD rates offered by larger banks. As a result, while the large private banks have cut non-bulk TD rates by 10-30 bps in the last nine months, the bulk TD rates have been revised upwards. 

Expect only 10-15 bps increase in loan yields from here: 

Increase in loan yield thus far (125-230 bps) has been a function of both loan re-pricing, as well as rise in the share of higher-yielding unsecured loans (benefit of 5-50 bps to yields). Analysts of IIFL Capital Services analysis of the past rate-cycle suggests limited room for MCLR to increase (maximum 25 bps). Factoring in residual re-pricing of MCLR linked loans and a 25 bps increase in fixed rate loans, analysts of IIFL Capital Services estimate further loan yield increase of only 10-15 bps across the banks under their coverage. 

Residual deposit re-pricing to drive divergent margin outcomes: 

Cost of funds have already increased by 105-140 bps for the banks under analysts of IIFL Capital Services coverage, and will rise further due to lagged deposit repricing. By comparing the current time deposit (TD) rack rates with the estimated flow-through of term-deposit hikes in the P&L, analysts of IIFL Capital Services estimate the TD re-pricing remaining. They further assume 100 bps of CASA ratio decline from the current levels. Analysts of IIFL Capital Services thus estimate funding cost to increase further by 5-50 bps for the banks under their coverage; higher for ICICI and Kotak in their view. Basis their analysis of the potential residual loan and deposit re-pricing, they expect spreads to decline further by 5-40 bps. ICICI and Kotak should see higher NIM compression; and lower for Axis and SBI. On the other hand, it should be stable-to-better for Federal, HDFC, RBL, BOB and IIB.