Banking: Credit demand

While credit growth is expected to improve, tight liquidity and slow deposit growth keep the spotlight on banks

The banking sector has seen a strong run-up in the past month, gaining nearly 13 per cent, although credit growth is still below the Reserve Bank of India’s 20 per cent projections for 2010-11. In fact, credit growth in September slipped to 19 per cent, with systemic loan growth, excluding the 3G and BWA loans at 17.5 per cent (a 200- basis point rise in the year to date) according to a Motilal Oswal report. The pinch was because of the base rate implementation, which bumped up lending rates in line with the deposit rate increase, pushing companies to tap the debt markets and leading to higher corporate paper issuances.

Net interest income growth after the rise in rates is, therefore, expected to be robust, especially on the low base of last year. Margins, too, are expected to show a strong improvement on a year-on-year basis because of the same reasons but would be flat sequentially. Slippages from the restructured farm loan waiver book should continue and are expected to peak this quarter, although non-performing loan ratios should not deteriorate further. Public sector banks are expected to have bottom line growth moderate a little, as they account for pension provisioning and gratuity requirements this quarter.

Going ahead, an improvement in credit demand is expected, as capital expenditure would pick up after the monsoon. Also, the second half is traditionally busier, which bumps up working capital requirements, and together should see credit growth pick up in the second half.

The key is the lag in deposit growth this quarter of around 14 per cent, y-o-y. This is expected to push up deposit rates, according to a report by HSBC which envisages margin pressures for the sector as a whole. The major reason is that liquidity has been tight for some time, with banks borrowing from RBI through the repo window and money market rates trending to the upper end of the Liquidity Adjustment Facility corridor. However, with incremental credit-deposit ratio at nearly 100 per cent, Motilal Oswal sees enough room in credit demand for banks to pass on the rate increase, keeping margins steady.

However, margin pressures could come to bear on banks with lower Casa (current and savings accounts). On that basis, large public sector banks which have reasonably good Casa and also have higher provisioning coverage are preferred picks in the sector. However, most banks are trading at expensive valuations, except ICICI Bank, as its improving asset quality should bring down provisioning requirements and boost its bottom-line outlook.