Market-linked loan pricing may increase deposits

By: | Published: December 7, 2018 2:21 AM

The move to link pricing of small-value bank loans to an external benchmark could lead to an increase in the prevalence of floating-rate deposits in the system, analysts said.

These can lead to expansion in NIMs (net interest margins) by 5-10 bps and drive uptick in NII (net interest income) growth over two-three quarters, especially for banks with high CASA (current account savings account) levels,” the broking firm said.

The move to link pricing of small-value bank loans to an external benchmark could lead to an increase in the prevalence of floating-rate deposits in the system, analysts said.
On Wednesday, the Reserve Bank of India (RBI) had said it would be issuing guidelines for banks to link interest rates on floating-rate loans to individuals and small businesses to an external benchmark 2019-20 onwards.

Investment bank Jefferies said in a note on Thursday that the proposed pricing structure of floating-rate loans could, at some point, lead banks to link interest rates on deposits to money market rates to reduce volatility in margins. “But since such a structure could hurt the pseudo risk-free identity enjoyed by bank deposits, we don’t see this structure getting to be a frontline product in the medium term. As an alternative, we believe banks could turn to swap markets to hedge the volatility in lending spreads, and create/deepen that market,” Jefferies said in the note.

The Bank Nifty on Thursday ended 1.21% lower than its previous close as fears of banks facing a margin squeeze persisted a day after the central bank’s statement.
According to Jefferies’ estimate, State Bank of India (SBI), ICICI Bank, Bank of Baroda (BoB), Axis Bank and Kotak Mahindra Bank could see 35-45% of their loan books come under the proposed external benchmarking system, while HDFC Bank and IndusInd Bank may have to price only 15-20% of their book as per the new mechanism.

Housing loan portfolios are likely to be most affected as vehicle loans and personal loans are typically fixed-rate.

Other experts pointed to the possibility of asset quality in small loan categories taking a hit. Kotak Institutional Equities (KIE) wrote in a report that volatile swings in interest rates during periods of uncertainty, such as the taper tantrum or demonetisation, could hit borrowers’ ability to repay. “This could also raise asset quality risk as these products are high on installment-to-income ratio,” KIE observed.

To keep up with banks, non-bank lenders, especially housing finance companies (HFCs), may have to switch to the external benchmark-based pricing mechanism. This could risk asset liability mismatches, with HFCs opting for more floating rate borrowings or squeeze their margins as they buy swaps against
long-term fixed rate borrowings, KIE said.

However, the fears of margin compression may be overdone as banks have been able to charge high spreads over their deposits while lending in recent months.
Spreads on loans over deposits have expanded to a two-year high, with spreads on mortgage- backed securities expanding by up to 100 basis
points (bps).

“Moreover, weaker inflow into debt mutual funds is driving shift of market share to banks. These can lead to expansion in NIMs (net interest margins) by 5-10 bps and drive uptick in NII (net interest income) growth over two-three quarters, especially for banks with high CASA (current account savings account) levels,” the broking firm said.

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