If the aam aadmi has been rattled by the cash-crunch post the Centre’s demonetisation move, banks that have been on the firing line, are up against a host of new challenges. After three long years of slowdown, the banking sector had been pinning its hopes on recovery of sorts. With balance sheet repair underway, post the RBI’s asset quality review, banks were just about prepping the pitch for the next leg of lending.
But the joker in the pack---demonetisation—has once again roiled the picture. In the second half of this fiscal, gains from a sharp fall in cost of funds and strong treasury income, will be offset by the marked slowdown in credit growth, steep lending rate cuts, risk of higher delinquencies and surge in costs.
But short term disruption aside, structural recovery in the sector is now under a cloud. While it is still early days to gauge the full impact of demonetisation, new loan growth---key to the revival of the sector—will take a knock, pushing recovery down several quarters. We remain cautious and recommend investors to be selective while stock-picking.
Here are 4 trends and their likely impact on banks’ performance in the 2018 fiscal
Surge in deposits
Demonetisation has indisputably aided banks on one front—high accretion of deposits. The withdrawal of legal tender character of old Rs. 500/1000 notes from November 9, and subsequent caps on drawing out money from banks and ATMs, have left banks flush with deposits over the past two months.
Sample this. Between October 28, 2016 and December 23 2016, banks’ deposits have shot up from around Rs. 107 lakh crore to 112.6 lakh crore---an increase of about Rs. 5.5 lakh crore in two months. This is nearly twice the amount of deposits that flowed into banks between April and October 2016.
But how much of this increased liquidity will stay on in the banking system, once currency flow normalises and various caps on withdrawal are lifted?
Few bankers are of the opinion that the current level of 40-50 per cent retention of deposits, can go down to 20-30 per cent over the course of the year. This means that even if we assume that about two-third of the deposits coming into the system are withdrawn finally, the growth in deposits at the end of FY17 and FY18 fiscal will be notable and higher than the 9-10 per cent growth seen in 2015-16
Fall in cost of funds:
Over the past two months, with bank deposits swelling, deposit rates have fallen by a substantial 50-75 basis points across banks and tenures.
While such a steep fall is unlikely again, banks retaining a portion of the deposits (in the form of CASA and term deposits), will continue to trim deposit rates.
This should lead to reduction in banks’ cost of funds through the next fiscal (2018).
The uptick in deposits will be commensurate with the market share of banks.
PSU Banks that command a lion’s share (over 70 per cent) of the deposits, will be the biggest gainers of the rise in deposits, leading to lower cost of funds.
Good appetite for government bonds:
After the sharp rise in funds post demonetisation, banks began lending such surplus to the RBI under the reverse repo option. PSU Banks, in particular, aggressively deployed excess funds in government bonds too. The fall in bond yields is likely to add 15-20 per cent kicker to banks’ earnings in FY17.
As withdrawal caps are lifted, and banks are able to gauge liquidity scenario better, parking huge sums under the reverse repo window will likely halt. Banks instead will look to deploy these funds for a longer term. Given the slackness in credit growth, particularly in PSU Banks, a large portion of excess funds will continue to find its way into the government bond market. This should bump up banks’ treasury income in FY18 and aid earnings to some extent. But after the sharp rally in bonds last year, treasury gains will likely moderate in FY18.
In the month of November, PSU Banks have been net buyers in government securities to the tune of about Rs. 25,900 crore. Private Banks too bought (net) around 20,000 crore in November. In the month of December, the buying spree continued for PSU Banks, who made net purchases of a whopping Rs.61,000 crore, even as private banks turned net sellers.
Slackness in lending
Banks flush with liquidity, in a falling interest rate scenario, is a perfect recipe for boosting lending. But tepid borrowing appetite by highly-leveraged corporates and banks’ reluctance to lend, has failed to spur loan growth, even after a substantial fall in lending rates over the past year. Even before demonetisation, credit growth had slipped to 8 per cent levels in the beginning of November. According to the RBI’s latest figures (as on December 23), credit growth has fallen to a meagre 5.1 per cent, down from 10-odd per cent levels last year. The growth had already fallen to 5 per cent levels in November, as credit to industry (corporate) shrunk by 3 per cent.
Credit growth has been closely linked to the pace of economic growth, growing at 2.5 to 3 times the real GDP growth in the past. The multiple at which bank credit has grown in relation to real GDP has however shrunk over the last two to three years. This is partly explained by the Centre’s move to a new series of GDP two years back and weak credit offtake in public sector banks. In 2014-15 and 2015-16, bank credit has grown at 1.2 to 1.4 times real GDP growth (new series) and about one time nominal GDP growth.
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