Banks, compared to other sectors, have been vulnerable to numerous market cycles, and Indian lenders have reasonably withstood them in the last two decades. While each cycle may seem similar, they are far from being the same. 

Therefore, if we must draw a parallel to 2013’s taper tantrum, the situation is different now. 

To start with, banks were prepared for rate hikes in FY23, though the quantum has taken them by surprise. Second, in terms of balance sheet strength, with most bad loans well-provisioned and banks having at least a quarter’s provisioning cost as buffer, they are in a better position to handle the rate hike. 

Cost benefit to shrink 

But here’s the catch. The relevance of deposits to the overall liabilities of banks has significantly increased compared to 2013. Now they account for 80-85 per cent of liabilities (excluding equity and reserves and surplus) against 70 per cent about a decade ago, when the dependence on bonds was a lot higher.  So, with a part of liabilities being tied to low-cost options, banks had the leeway to hike deposit rates to ensure liquidity, without taking an immediate knock-on cost of funds. 

This time around, cost of funds is at a historical low of 5.5 per cent or lower for the crème of private and public sector banks, and how well they can reprice it without compromising on their profitability (or net interest margin) is the question. In fact, what really gave a fillip to banks’ earnings in FY21 and FY22 was the low cost of funds. Therefore, even as the interest income grew by sub-10 per cent for top 10 banks, a significant reduction in interest costs helped a buoyant net interest income growth in FY21-22. In FY23, the cost benefit may reduce. 

Impact on loans 

For instance, banks have already seen the repo rate increase by 90 bps since May 4. To partly hedge their profitability, banks have passed on almost entirely the 40 bps of first rate hike, and may even pass on the 50 bps hike that happened today. 

Passing on the first phase of rate hikes isn’t perceived negatively from a credit demand perspective as borrowers usually prepone their purchases or avail credit in anticipation of further hikes. While in the upcoming June quarter NIMs may not be hurt much, investors should look out for loan growth projections from banks. Inflation unabated at the RBI’s upper tolerance limit of six per cent may be a threat to demand. 

NIM reduction

More importantly, the leeway of low cost of funds may thin and a higher cost of funds eat into NIMs. This could play out starting from the September FY23 quarter. Transmission of repo rates will have a bearing on the assets and the liabilities side of banks’ balance sheets. 

While the assets side transmission has been taken care of, the liabilities side transmission has been limited. For instance, while SBI hiked its bulk deposit (₹2 crore and above) rates by 40-90 bps in May, retail deposit rates have increased at best by 10-15 bps. Unlike repricing loans immediately, deposits haven’t been repriced yet. 

With excess liquidity substantially reducing, banks may once again have to turn to depositors for growth money. This time around, it won’t come cheap. Bankers opine that the 2016-2018 situation of luring deposits (including savings account) at attractive rates may once again play out. Given that the NIMs for most banks have risen by 100-150 bps since 2017 (at over four per cent for most private banks and over three per cent for PSBs), cutting some slack on profitability may be the way out to sustain growth. “With inflation and cost pressures coming at the same time, for growth to sustain FY22 levels, giving up a bit in NIMs isn’t a bad idea,” said a CEO of a private bank. 

Clearly, while FY23 may have started on a clean and strong note for banks, the challenges persist.

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