Bank stocks lag on concerns over treasury loss and slower growth

Higher interest rate, though, should help improve short-term margins and spread

The Reserve Bank of India’s (RBI’s) decision to raise policy rates by 90 basis points (bps) within two months has sent out a clear signal that it is trying to rein in inflation, which is well above its target range. It is likely to hike rates again and take other actions, such as raising the cash reserve ratio (CRR), to reduce liquidity.

The impact of the accelerated hikes could be somewhat unusual. Banks and non-banking financial companies (NBFCs) have started passing on the rate hikes, but will raise deposit rates more gradually than the rates at which they offer credit. Banks have raised their term deposit rates by just 10-25 bps in May and June and further hikes will also be gradual.

This is especially true for loans offered and benchmarked to external rates, since the interest payable will rise quickly. Faster transmission of changes in monetary policy on EBLR (externally benchmarked lending rates) loans should benefit banks. Such loans amount to 35-48 per cent of the loan books of most large private banks with a three-month reset clause.

Loans to micro, small, and medium enterprises (MSMEs) are around 70 per cent EBLR linked, while housing mortgages are around 60 per cent EBLR linked. However, large corporate loans are only around 20 per cent EBLR linked. This could result in a situation where spreads and net interest margins increase for lenders, at least for a brief period of one-two quarters. While that situation lasts, it’s good for lenders.
 

On the other hand, banks and mutual funds will have to take a hit on the mark-to-market portion of their bond portfolios, as bond yields rise. This will result in a drop in treasury profits. Since the last three years have seen a regime of high liquidity and low interest rates, which has led to high treasury profits, this may cause big changes in the bottom lines.

It’s unclear how much of an impact the interest rate hikes will have on credit demand. Before the hikes, in the March quarter (Q4), credit demand expanded around 9 per cent for the aggregated bank sector. The current interest rates are still relatively cheap, given the pace of inflation. If economic growth remains strong through FY23, as the RBI projects, credit demand should also expand despite rate hikes and despite expectation of further hikes.

This is not a black and white situation. If gross domestic product (GDP) growth accelerates, credit growth rates will rise but there will be some negative impact of the RBI’s policy normalisation. At the same time, inflation expectations are crucial when it comes to shaping economic decisions. If the central bank policy succeeds in dampening expectations, credit growth could be stronger.

Market valuations usually decline whenever interest rates rise and liquidity tightens. This is especially true for the financial sector. Share prices have fallen across the board since Wednesday, when the RBI announced the 50-bps hike. But the financial sector has reacted more.

While the Nifty has fallen from 16,416 (Tuesday close) to 16,202 on Friday, a decline of 1.3 per cent, the Bank Nifty has fallen 1.46 per cent and the Nifty Financials Services Ex-Bank has fallen 1.99 per cent.