Banks in Q4FY09: Margins could shrink

Falling spreads and slower credit growth could pressure net interest margins; profits from bond portfolio could fall.

With the economy very much in a downturn, it’s not surprising that the rate of growth of credit has decelerated sharply to around 19 per cent y-o-y currently from around 29 per cent in October last year. For one, companies themselves need less working capital because many have scaled back production. Also, falling inflation, in sectors like commodities, has meant they’re holding a smaller value of inventories.

Moreover, several big projects have been pushed back because companies aren’t confident about demand. Again, in a situation where there is money in the system, banks tend to lose pricing power with top quality firms. Retail borrowers, for their part, are yet to come to terms with a slowing economy in which the job outlook is uncertain and are therefore, not in a hurry to buy big ticket items like cars or houses.

In fact, banks themselves are reluctant to lend to firms that may not be so highly rated as also some retail customers because they fear the loans could go bad. Many are actually leaving huge sums with the central bank on which they earn just 3.5 per cent. Slowing credit growth is one reason why the March 2009 quarter results for banks may not be exciting.

The other is that spreads could contract because while banks have trimmed interest rates several times in the last six months, deposits are repriced with a lag. Together, it could mean a smaller growth in the net interest income and a fall in net interest margins. What’s more, in the December quarter, bond yields were down nearly 300 basis points which fetched banks huge profits from higher bond values.

In the March quarter, yields are up nearly 200 basis points, so gains on the bond portfolio will be negligible. If banks manage to show decent numbers it’s because the RBI is allowing them to restructure non performing loans (npls) on which they need to make provisions. But these npls could catch up with them in 2009-10 unless the economy sees a strong recovery.