Bank profitability to take a hit, deposit rates may be cut

The hike in cash reserve ratio (CRR) will shave net interest margins (NIMs) of banks by five basis points. The CRR hike, effective in two stages of 25 basis points each on April 26 & May 10, would suck out Rs 18,500 crore from the banking system.

?Banks are likely to face pressure on their NIMs by about 5 bps. Since there is no interest is available on CRR, it may exert even more pressure on the banking system,? said Vaibhav Agarwal, research analyst at Angel Broking.

If banks were earning an 8% yield on advances, losses will be to the extent of CRR. Banks earn no interest on cash balances deployed with the central bank.

?Year 2008-09 is likely to be more challenging, especially on margins, for government banks, and on loss of income from forex & collateralised debt obligations (CDO) provisions for private banks. We think bank earnings could be impacted for most government banks owing to the 60-75 bps cut in lending rates, early in 2008,? said Rajeev Varma & Veekesh Gandhi of Merrill Lynch in a report early this month, building a scenario of a CRR hike.

Rising inflation and weakening demand could impact volume growth. ?The key risks to the sector are a rise in interest rates, deteriorating retail asset quality and a further slowdown in loans and fees. In the current situation, with demand for credit on a slide, credit growth could be just about an average of 20% this year,? said a banking analyst.

The analyst explained that public sector banks might see multiple pressure points from Basel II implementation, loan waivers, labour demands and an inability to respond to interest rate signals appropriately.

Following the CRR hike, banks may slash deposit rates to protect their profitability.

?While banks have slashed lending rates, deposit rates still remain high. This can put serious pressure on banks. So banks will have to reduce deposit rates by a good 50 basis points,? said NS Venkatesh, MD & CEO at IDBI Gilts.

An analyst at a domestic brokerage said the total hit on the banking system would be about Rs 750-900 crore. ?Private banks may see a loss of Rs 300 crore if deposit rates are not slashed,? he said.