Banks Near-Term NIM Headwinds

The downtrend in lending and deposit rates has expectedly persisted and the following broad trends stand out:

• The lending rate on fresh loans (WALR (fresh)) has seen the greatest fall so far, particularly in the case of private banks,
• The fall in term deposit rates (WATDR) has exceeded the fall in lending rate on outstanding loans (WALR (o/s)),
• However, the fall in lending rate on outstanding loans is beginning to accelerate,
• The median MCLR too has trended down, but the reduction has been significantly lesser than that in lending rates on fresh loans and is more recent in case of private banks,
• Banks have cut their deposit rates sharply, with large private banks leading the way,
• Within our coverage universe of banks, most have seen a QoQ rise in their LCR and HQLA, and
• Most of these banks’ NIMs compressed QoQ.

We expect further compression, at least over FY21E. Our stance is premised on the following:

• Given the sharp fall in the lending rates on fresh loans and the more recent fall in the median MCLR, lending rates on outstanding loans will continue to trend down, putting pressure on banks’ yields,
• While most banks have cut deposit rates significantly, these rate reductions have been higher in case of shorter-term deposits,
• The fall in the cost of incremental deposits will result in further reductions in banks’ MCLRs,
• Banks’ asset-sides will be re-priced faster than their liabilities’ sides,
• Elevated slippages in 2HFY21E, as the moratorium is expected to come to an end, will result in high-interest reversals, and
• High liquidity will continue to drag NIMs.

On the NIM front, banks with a higher proportion of fixed-rate loans and strong liability franchises are likely to be better off. Within our coverage, we believe RBK is set to see the highest NIM compression. KMB is relatively better placed with as it will benefit from the sharp SA rate cut. We continue to prefer large private banks with strong liability franchises and superior capital adequacy.

An analysis of weighted average lending and deposit rates along with MCLRs yields the following trends:

• WALR (o/s): The WALR (o/s) has dipped 53bps since January 2019 to 9.74%. Much of this decline, is fairly recent, as the WALR (o/s) dipped 26bps between April and June 2020. Since January 2019, private banks’ WALR (o/s) has fallen 40bps, (29bps between April and June 2020). The RBI cut the repo by a total of 250bps over the corresponding period. The spread between the WALR (o/s) and the repo remained elevated at 570bps (670bps in case of private banks). We believe that this reflects weak policy transmission as well as a difference in loan book mix.