Why recent rate cut will not impact banks financials

Lenders had already cut deposit rates by up to 50 bps in recent months, providing some cushion; however, credit costs and asset/liability profiles will also vary between lenders.

At a time when bankers are restive about the likely negative impact of base rate (BR) cuts on net interest margins (NIM), many analysts believe otherwise.

First, most banks have already cut deposit rates (DRs) in select maturities over four to five months, so there is cushion available.

"The cuts in DRs, coupled with reasonable liquidity and lower wholesale funding rates, has been leading to reduction in cost of funds and was reflected in better margins in the December 2014 quarter and likely in the March 2015 quarter as well," says Manish Karwa, research analyst at Deutsche Bank.

He says while the margin impact of these cuts will be limited, any further rate cuts over the course of the year will impact bank NIMs.

Ajay Srinivasan, Director, CRISIL Research, says: “Lowering of the BR indicates the cost of funds for banks has declined, since it is calculated using DRs as the benchmark.

Thus, a decline in BR would not impact NIMs.” CRISIL Research expects NIMs to improve slightly in 2015-16, backed by a gradual economic recovery and an improving proportion of retail loans, which have higher yields, he says.

Last week, State Bank of India (SBI), ICICI Bank and HDFC Bank cut their BRs by 15-25 basis points (bps), after the Reserve Bank of India’s monetary policy review.

On Monday, Kotak Mahindra, the fourth largest private bank, cut its BR by 15 bps, to 9.85 per cent. Other banks are likely to follow.

Experts believe these cuts were long overdue, as RBI has cut rates by 50 bps in 2015 so far. However, there could be some pressure on interest income of banks.

SBI officials estimate a Rs 1,200-1,300 crore hit on interest income due to the 15 bps cut in BR. However, analysts say the impact on profit will be limited.

They believe SBI could witness a four or five bps NIM impact; for ICICI Bank, the hit could be of five-six bps.

With HDFC Bank, the impact is expected to be negligible, as a relatively low (20 per cent) proportion of its loan book is linked to the BR.

In ICICI and SBI, this ratio is 50 per cent and 80 per cent, respectively.

However, NIM movement is not contingent only on rates and is determined by other key factors such as credit costs, too. There are other factors that will have a bigger bearing on banks' profitability.

This includes other income, expected to be robust, and a possible increase in credit costs in the near term. Credit costs pertain to the amounts set aside by banks for non-performing assets (NPAs) and restructured loans.

Vaibhav Agrawal, vice-president, research–banking, Angel Broking, says bank NIMs should improve in the March quarter due to a three to four bps savings in cost of funds.

He believes the quarter would have the full impact of DR cuts and, hence, might aid NIMs.

However, higher credit costs on account of increased NPAs could offset these to some extent.

IDBI Bank executives, too, indicate that when clubbed with credit costs, the NIM impact will be more pronounced.

Thus, banks, especially from the public sector, which have much higher credit costs will witness higher margin contraction.

The actual impact will vary from one lender to another.

“We believe bank-specific NIMs would vary quite meaningfully.

Historical margin profiles show the movement of bank-specific margins in an easing/tightening cycle are dependent on other factors as well, such as the share of fixed rate loans, share of wholesale deposits and changing asset-liability profile”, analysts at Ambit Capital write in a recent report.

They believe IndusInd Bank is best placed to protect its margins due to its high fixed rate portfolio, higher share of floating rate liabilities and improving liabilities.

But, if banks cut BRs aggressively, the impact on their NIMs could be more prominent, which some analysts believe is a possibility.

Adarsh Parasrampuria of Nomura says, “Given that banks have cut DRs by 25-50 bps in the past six to nine months, we would expect them to now accelerate the BR cuts.

This will have a negative impact on bank margins, especially for public sector ones, in the interim. We believe bank margins, especially for corporate/PSU banks, will be negatively impacted, due to faster transmission in a falling rate environment.

The impact on retail private banks will be lower, as 40-50 per cent of the loan book is fixed in nature.”