The way ahead for the banking sector - GEPL Capital

The Banking sector is facing immense pressure due to the guidelines which RBI has imposed. Initially on 15th July RBI fixed the borrowing limit for banks at 1% of the system's net demand & time liabilities or bank's total deposit base. But lately, it has reduced the Liquidity Adjustment Facility (LAF) to 0.5%, thus limiting the access to borrowed funds from central bank. It will also prevent incremental demand from rollover of external commercial borrowing into rupee debt from the banking sector. Additionally it has made mandatory for banks to maintain 99% of CRR requirement on daily basis from earlier prescribed limit of 70% of the required CRR on a daily basis during the fortnight.

The reason for such stringent measures to be taken is mainly to help control the rupee from weakening further & discourage demand for USD. The spread between the Indian 10 year G-Sec & US 10 year G-Sec had narrowed down to approximately 500bps from 700bps Y-o-Y. The narrowing spread was a major reason because of which the rupee was weakening. These measures would help widen the gap between the Indian-US treasury spreads which is currently now at ~600bps.Capital flows into India has been higher than justified by the underlying growth. Also GDP for FY13 stood at 5% which is significantly higher than it's estimate. This implies higher susceptibility of tapering global excess liquidity.

The impact of reducing LAF from 1% to 0.5% would mainly affect banks with shorter maturity & higher share of wholesale deposits such as IndusInd Bank, Kotak Mahindra Bank, Yes Bank, ING Vysya Bank who have almost 60% deposits which would mature within a year.

Q1FY14 Result Highlights of some of the major private sector banks:

Operation has been superior as it plays dual roles i.e. an incumbent in 11 circles and new in remaining circles. Idea has gained market share in terms of revenue in its top 5 circles in last 3 years as compared to its competitors who have lost their market share in their top 5 circles. Idea has gained around 210bps market share during the same period. We expect this trend to continue even in coming years.

Considering the aggregate we can conclude that Net Interest Income (NII) has remained flat over the quarter & improved by 24% on Y-o-Y basis. Also the NPA's have increased significantly both on Y-o-Y & Q-o-Q basis. Around 2 months back RBI finalized guidelines that will require banks to raise their provisions on restructured loans to 5% from 2.75% currently. The RBI began applying the provisioning guidance on new restructured loans on 1 June, but has opted to phase in implementation on existing restructured loans, with provisioning set at 3.50% by March 31, 2014, 4.25% by March 31, 2015 and 5% by March 31, 2016.Indian banks' restructured loans have increased in the past two years, and 15-25% of restructured loans eventually slip into non-performing loan (NPL) classification within 12 months of restructuring. Banks borrowed Rs. 228.50 bn from the Reserve Bank of India's marginal standing facility window on July 26, the largest amount since the central bank tightened cash conditions and raised shortterm rates two weeks ago to support the rupee. The RBI had raised the marginal standing facility (MSF) rate by 200 basis points to 10.25 % and also imposed restrictions on daily borrowings by banks under its repo window. Banks usually tap the MSF rate during acute cash tightness.

RBI's monetary policy dated 30th July 2013:

In the first quarter monetary policy of 2014, RBI left key rates unchanged but it also hinted at increasing rates in future depending on the market stability. The repo rate at which banks borrow money overnight from RBI remained at 7.25%, while the reverse repo rate at which banks park their surplus money remained stable at 6.25%. The CRR ( Cash Reserve Ratio) stood at 4%.Also the Marginal Standing Facility (MSF) at which banks borrow from the RBI after exhausting the repo option too remained at 10.25% which is 300 bps above the Repo Rate. The central bank considered the external sector risk as the biggest threat to aggravate the rupeedollar currency movements. The Indian currency has already fallen nearly 6 percent between May 22 and July 26 due to capital outflows by overseas investors, who are nudged by the US monetary policy stance. While short-term interest rates are likely to increase, the foreign exchange market should get a positive sentiment. Banks are expected to rush to MSF window to raise overnight money at 10.25%.

The way ahead for the banking sector

The recent steps taken by RBI of tightening the liquidity in the market by increasing the marginal standing facility by 200bps to 10.25% & reducing LAF from 1% to 0.5% has had a significantly negative impact on the banking sector. In the recent monetary policy dated 30th July,2013 RBI kept the key rates unchanged but also hinted on increasing the rates sooner & if it does the same it would be even more negative for the banking sector. So the way ahead for the banking sector is very cautious as RBI's measures will affect banks and non-banking finance companies (NBFCs) in two ways: One, directly through the NIM (net interest margins). Two, indirectly through the impact on GDP growth. In terms of direct impact, banks that are most reliant on short-term wholesale funding will be the most affected such as Yes Bank and IndusInd Bank as they significantly rely on wholesale funding. So all in all banks are a negative bet for the short term, until & unless RBI introduces measures which would be in their favour.

Source : Equity Bulls

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