A balancing act

SPECIAL REPORT

Banks have started cutting deposit rates to maintain margins in response to the recent monetary policy measures.

No matter what central banks the world over do with interest rates, investors continue to fancy Indian banking stocks. The BSE Bankex ended last week with a gain of 9.4 per cent as compared to Sensex gain of 3.8 per cent.

This is despite the 50-basis point hike in the cash reserve ratio (CRR) "� the money banks have to keep with the central bank "� to 7.5 per cent by the Reserve Bank of India. The hike came a day before the US Federal Reserve's 25 basis point cut in the Fed rate to 4.5 per cent.

In a scenario where foreign money has been pouring in, how far will the recent CRR hike help in containing the copious flows? What will be the impact on banks' margins, which were already reeling under funding cost and competitive pressures?

The RBI has raised the CRR by 200 basis points since January 2007 to control the liquidity in the system, most of which is coming from the foreign inflows.

Foreign institutional investors (FIIs) have pumped in over $17 billion till date in 2007, almost twice the amount invested in the whole of 2006. Around half of this money came after the Fed cut interest rates in September.

The CRR hike will suck out Rs 16,000 crore from the system, which is not significant. Says Nandkumar Surti, chief investment officer, JP Morgan Asset Management, "Systemic liquidity continues to be adequate at around Rs 2,19,000 crore and we do not see any material impact except some tightness for the next three-four weeks due to the festive season."

Says Rana Kapoor, managing director and chief executive officer, Yes Bank, "I expect overall liquidity to remain adequate in the wake of healthy inflows and RBI intervention in the currency market with intermittent bouts of liquidity tightness."

However there are some players who are uncomfortable with the move. Says Anil Jaggia, chief operating officer, Centurion Bank of Punjab, "Any CRR hike is negative for the banking system, especially when there is no interest paid on the money kept with the central bank."

The most immediate and direct impact of the CRR hike is that lending rates will neither be easing soon, nor are bankers expected to hike rates as credit offtake is down from 30 per cent last year to 23 per cent.

In order to reduce the pressure on costs, some banks such as SBI, PNB and Union Bank have already reduced deposit rates. Analysts estimate that if banks do not cut deposit rates, their net interest margins will be hit by 4-5 basis points.

However, the banking sector, which was scrambling for resources, has got a new ray of hope for raising money without diluting equity as the RBI has allowed preference share issues, which are eligible as Tier-I capital (up to 40 per cent). This is especially positive for public sector banks as they can raise money without diluting government's holding.

Says Sejal Doshi, chief executive officer, Finquest Securities, "Return on equity of banks going for preference share issues will improve substantially."

Banks which have a higher proportion of current and savings accounts (HDFC Bank and SBI) in total deposits and more than the required statutory liquidity ratio requirements will be in a good position to maintain margins.