Rate wars to commence?

(The views expressed in this column are the authors’ own and do not represent those of Reuters)

By Robin Roy and Sanjoy Majumder

Indian banks are facing a dual challenge. Monetary tightening by the RBI is already impacting the banks’ margins and due to an imperfect monetary transmission system, banks are not able to pass off higher lending rates to the borrower across the board.

Also, the savings rate deregulation would raise the costs of raising core deposits (consisting of sizeable proportion of saving banks) and again impacting margins. Estimates of the impact on NIMs in the current fiscal across the sector range from 50 basis points to over 100 basis points, depending on share of the savings bank in the deposit kitty.

In the first reaction to deregulation of the savings bank rate, a few of the private banks who have a low CASA (Current Account, Saving Bank) below 15 pct  increased savings rate to attract more depositors in this category.

India is an imperfect deposit market, where deposit rates are positively correlated with interest rates. This was only for term deposits till now. As the savings rate gets linked to the interest rate cycle, banks with high CASA will find it a challenge in protecting their margins.

Increasing current ratio in a linear manner is fraught with risks of volatility in a high inflationary environment. Banks’ operating margins can be hit by more than 7-8 pct, for large banks having a high (over 40 pct) share of CASA. The stranglehold of the large banks on distribution (larger network) and over 30 pct of branches in PSBs being in rural (where apart from the humble post office, there is no competition) has not prompted  these banks  to increase savings rate yet.

On the flip side, increase in base rate among banks (due to cumulative impact of RBI’s repo rates) will push up lending rates for SMEs and consumer loans in turn leading to higher NPAs.

The challenge that the Indian banks currently face is to balance growth vs sustainability, which will continue to ensure a strong banking sector. Over the last 3 years, the median balance sheet size of the top 50 banks in India has gone up by more than 50 pct and mere pursuit of balance sheet growth could bring on pressures on quality of portfolio, due to lending to riskier borrowers.

This is evident from the noticeably higher Gross NPA levels in the last three years. Add to this contribution to such growth in size by retail banking, which brings on heightened pressures on both operational (increased no of borrowers) and credit risks (concentration in Tier 1 & Tier 2 type of cities).

Banks lent aggressively (average CAGR of over 30 pct) encouraged by an economy that was registering scorching growth (GDP at 9 pct+), and the interest rates were more benign. As the pace of this growth itself slows, there is the domino impact on loans evident from the recent results of banks, particularly public sector banks.

Our Best Bank 2011 survey shows that while the median balance sheet size of public sector banks has grown at 19 pct (2009-11), NIMs have increased from 2.32 pct to 2.79 pct, however the Gross NPA has grown at 28 pct in the same period. The private sector banks as a group have done better, with balance sheet size having grown at 18 pct, NPA at only 4 pct and NIMs moving up to 2.88% to 3.18% pct in the same period.

Banks who have balanced growth with sustainability are very few.

Higher interest rates are already impacting growth, and it is imperative for banks to be more efficient to protect their margins. A quick glance at some of them would indicate a general lack of a long-term cost management strategy:

•     Lack of proactive cost management and identification of cost islands

•     Limited product line, geographic wise cost data

•     Managing increasing sectoral/segmental NPAs, without hurting overall business growth

•     Concentration of small banks in particular region making them susceptible to changes in the economic fortunes of that region

•     Slow growth and loss of fund-based advances (due to competition from capital markets and private equity) leading to fall in non-fund based business.

Robin Roy is an Associate Director in the Financial Services practice of PwC. His experience encompasses a broad range of financial services segments like banking, asset management and insurance. He has worked over 20 years in the banking sector and his core experience is in Corporate, SME, Consumer & multi-channel banking models.

Sanjoy Majumder is a Senior Consultant in the Financial Services practice in PwC. He has more than 11 years of experience with around eight years in the area of financial and risk analytics, market feasibility studies, business process re-engineering and equity research.

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