With RBI unmoved on rates, pressure could build on banking stocks

Unless RBI temporarily relaxes the norms on recognising of bad loans, the pressure on this front could rise in the December quarter.

Much to the Street’s disappointment, the Reserve Bank of India kept key policy rates unchanged in its monetary policy review announced on Wednesday. This rubbed off negatively on banking stocks, which fell by one to three per cent. The Nifty Bank fell one per cent, twice the fall in the Nifty 50 index, and is down 6.5 per cent following the demonetisation move. 

“Assuming that RBI would cut rates, the markets were factoring in higher treasury gains which would have compensated partly for the losses that banks will suffer due to demonetisation. Analysts might have to tweak their assumptions on that front,” says Santosh Singh, banking analyst at Haitong Securities.

This more than offset the positive of a roll-back of the incremental cash reserve ratio hike from the 10th of this month. For one, it was known from the start that the CRR measure was transitionary. Two, this roll-back will add only five to seven basis points to the banking sector's margins, estimate analysts. So, it will not have a meaningful impact on their earnings. 

It is important to note here that as anticipated earlier, banks might not benefit much from the demonetisation exercise. This is because, as most experts believe, they are unlikely to cut lending rates in a big way over the next two to three months.  

Alpesh Mehta, banking analyst at Motilal Oswal Securities, says: “In the near term, a lending rate cut could be less than 25 bps. Banks would wait and watch to reassess the impact before any big action on rates. First, credit demand continues to be weak. Second, banks have incurred additional costs on demonetisation.” 

Thus, though banks have already trimmed rates on deposits, a strong surge in other costs would prevent any big lending rate cuts, say analysts. In fact, most believe that banks will witness weak growth in fee income (as charges on ATM transactions were waived), interest income and in increased asset quality pressure, thanks to demonetisation.

The latter is also expected to have a negative impact on demand and, hence, businesses. Thereby, hurting their ability to service debt. Unless RBI temporarily relaxes the norms on recognising of bad loans, the pressure on this front could rise in the December quarter.

Another important dimension is how much of the deposits received by banks (Rs 11.55 lakh crore so far) due to demonetisation will stay with them. Most analysts believe once the withdrawal limits are eased, there will be little left of the incremental deposits.

“If only 10-20 per cent of this stays back in the system, that is miniscule compared to the total system. Thus, the impact of the additional liquidity created via demonetisation on the lending rates will be minuscule,” adds Singh. 

Mehta believes that demonetisation and digitisation together could boost banks’ current account and savings account deposits by Rs 1-3 lakh crores. 

Overall, the financial performance, as well as stock price returns, of banking stocks could be under pressure in the near term as the negative effect of demonetisation and slower economic growth plays out. RBI, on Wednesday itself, cut India’s Gross Value

Added growth forecast for FY17 from 7.6 per cent to 7.1 per cent.

It also saw headwinds to inflation from elevated prices of certain food items, as well as rising global crude oil prices. Long-term investors, though, could use any meaningful correction to pick high-quality names in the space. Apart from State Bank of India, analysts largely prefer private sector lenders.

Image: RBI Governor Urjit Patel (extreme right) along with deputy governors (from left) N S Vishwanathan, S S Mundra and R Gandhi, during a press conference announcing the RBI monetary policy in Mumbai on December 7, 2016. Photograph: Mitesh Bhuvad/PTI Photo.