Additionally, post-cut margins could set the foundation for gradual expansion, driven by factors such as improved liquidity, the repricing of fixed deposits, and stronger growth in higher-yield loan segments. Edited excerpts from an exclusive interview with Santanu Chakrabarti:
Q: The common thesis is that when the rates start getting cut, banks are going to suffer because their margins will decrease. loan rates will come down. Tell us why you don’t believe that thesis?
A: There is a lot of validity to the argument that the moment rates get cut, especially since a lot of loans on the bank side are now linked to repo rates directly, there will be a pressure on margins. Now, that’s a fair point, that the margin bottoming happens only after rate cuts. We believe that the market seems to have kind of lost the perspective a little bit, is that what do the influences of those rate cuts are in the context of overall earnings.
The flip side of this is the same argument is applied to NBFCs, that NBFCs with a lot of fixed-rate assets, or even with a lot of fixed-rate assets, are huge beneficiaries. In the overall scheme of things, what we have to remember is – and this is the analysis that we have done – if we price in the rate cuts for the entire part on which repo rates apply, give the benefits of repo rates to all market-linked borrowings as well, then on a net basis, the total influence on most earnings, second half, is about 3-6%. Now, we have already been building in rate cuts, so these are not earnings estimate changes that we have made. But we wanted to give some context on what the overall number is.
What we also wanted to point out is that the margin-bottom post the rate cuts sets the base for a gradual margin expansion from that point. There are three or four major factors that drive this. One is that easier liquidity and a lower gap between savings accounts and fixed deposit rate means good things for current account savings accounts (CASA). Second, fixed deposits (FDs) also start to reprice. In a more growth-enabled environment, it is likely that more high-yield segments within the banking loans will probably go faster. So, all of this sets the stage for a benign and gradual margin expansion, which, coupled with reasonable credit growth, translates into reasonable earnings growth. And that’s the crux of our argument, that probably there’s no reason to freak out about the rate cuts.
Q: What would be the impact on margins, you think? For a marquee bank like ICICI Bank, or even, for that matter, SBI, the margins can, what, go down by 10 basis, how much is the crunch?
A: For most of them, the total impact of this is 10 to 15 basis points. This is without building in benefits that might well come in in terms of FD repricing. If I just take the two primary drivers of margin squeeze, which is essentially what happens with the repo-linked loans, and only build in benefits that directly come into the CD part of their liability portfolio of course, what you are getting out there is an overestimate of the influence. But nevertheless, on the half-yearly earnings, it is 3 to 6%, not even on the full year earnings.
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Q: One point that doesn’t get discussed enough, or maybe I am making much about it wouldn’t there be mark-to-market gains? Look at the big fall in yields. I mean, 10-year went to 6.71 yesterday after the borrowing program came as expected, it is 6.73. But it is still so much lower, 50 basis point lower than what it was, say, 6-8 months ago. Won’t there be mark-to-market gains?
A: Yes, there will be. But there are two parts to this story. Mark-to-market gains would be directly proportional to what kind of modified durations are these banks running. This is where PSUs are positioned a lot better than private banks on this particular parameter, because they generally run higher durations than what the private.
Most private bank portfolio durations are like six months to nine months, modified duration, which means – that a 100 basis points swing is 0.6% to 0.9% gain on the, I am not saying it’s nothing, but it’s not a make or break on the earnings trajectory.
Q: What’s your best estimate of when deposit rates peak? It is already peaked or do you think there is perhaps one more quarter when deposit rates will be raised?
A: I think deposit rates have peaked for the most part. If we are expecting an October cut between now and over the next 20, 30 days, can one bank go out there and raise some rates in a bucket or no, this is very hard to guess. But for the most part, in any practical sense of the term, deposit rates have peaked.
Interestingly, what you can see, is the back-book yields of the FD books of all of these banks have pretty much converged with what their incremental FD rates are.
For full interview, watch accompanying video
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