Deposits to cost more: Crisil

Deposit rates will continue their upward march in 2007-08 as banks fight intensely for resources to feed high octane credit growth. While this is good news for depositors "" retail and corporates "" as they get a better deal, bank profitability will suffer owing to pressure on margins.

Rating agency Crisil, a Standard & Poor's company, expects average cost of funds to go up by 50 basis points to 5.6 per cent for banks in 2007-08. In 2206-07, it was 5.1 per cent.

While there has been an increase in low-cost current account and savings account (CASA) deposits over the past few years, costs have increased owing to changes in the composition of term deposits.

The analysis of the banking sector reveals that the proportion of bulk deposits (deposits above Rs1 crore), which carry higher interest rates and have relatively shorter tenures, has increased over the past five years.

The share of bulk deposits of total deposits was close to 20 per cent for year ending March 2007. This is 2-3 per cent more than share in 2005-06.

One-year retail deposit now fetches anywhere between 9.00 and 10.5 per cent annually, while bulk deposits rate are quoting 100 basis points above retail rates, Tarun Bhatia, head - financial sector ratings, said.

More than half of the term deposits mobilised in 2007 had tenures of less than a year, as against less than a third in 2000, resulting in frequent deposit renewals and thus exposing banks to interest rate risk.

Though costs of substantially, banks have improved their profit margins in 2006-07 through many revisions in prime lending rates. Despite the 60 basis-points increase in cost of deposits, the banks' net profitability margin (NPM) increased to 1.55 per cent in 2006-07 from 1.32 per cent in previous financial year.

In Crisil's opinion, banks may not in position to pass on increasing costs to borrowers in this financial year, as it can hampers credit demand or force borrowers to look for other avenues to raise funds. Many corporates have increased their reliance on foreign currency borrowings as the overall cost is much lower.

On the impact of revised Basel II norms on the banks, Crisil said the overall capital adequacy in the system is likely to improve by around 10 basis points.

The revised guidelines released recently by the Reserve Bank of India link a bank's capital to the estimated degree of risk associated with its borrowers. Public sector banks are expected to gain significantly from the norms as they have a large exposure to higher-rated (AAA, AA, A) borrowers.

In this environment, Crisil believes that credit indicators of its portfolio of rated banks will continue to be stable. It does not anticipate any significant changes in the majority of our bank ratings over the short to medium term.