The gradual rise in yields has led to a situation where spread between bank funding and bond rates have gradually started to converge.
As per the latest data by Reserve Bank of India, term deposit rates saw a modest 5 basis points (bps) month-on-month (m-o-m) increase in November 2018 (up 15 bps since May 2018). Term deposit rates had seen strong upward movement from November 2017 to March 2018 by 20 bps to 6.7% but were flat thereafter with a marginal 15 bps rise until September 2018 to 6.8%. Wholesale deposit cost (as measured by CD rates) has declined by 15 bps m-o-m in November 2018 but increased thereafter by 10 bps.
Average term deposit rates are broadly similar to term deposit rates (1-2 years) offered by most banks today, thereby indicating a stable deposit rate trend over the near term, though gradual rise in CD ratio might push some private banks to raise deposit rates in an environment of strong loan growth (up 15% yoy in past few months).
Fresh loans see marginal improvement for private banks
Fresh lending rates saw an upward movement by 10 bps in November 2018 to 9.9% post remaining flat in 2QFY19. Private banks saw 5 bps m-o-m rise in weighted average lending rates (WALR) on fresh loans to 10.4% whereas it was flat m-o-m for PSU banks. Foreign banks saw a sharp rise in WALR on fresh loans to ~9.5% (up ~25 bps m-o-m). MCLR rates continue to hike upwards, albeit at a slower pace than that observed during May-September 2018. MCLR rates were, however, flat m-o-m in December 2018 for private banks at 9.3% and was up 5 bps m-o-m to 8.75% for PSU banks. With deposit rates broadly stable, a swift rise in MCLR rates is less likely.
Gap between outstanding lending rates & new loans narrows
The gap between outstanding and fresh lending rates has started to converge (lowest at 0.5% since MCLR inception; down 5 bps m-o-m). The gap has been in the range of ~70 bps over July-September 2018 and below 60 bps since October 2018. Spreads for both private and PSU banks remained flat m-o-m at 0.6% in November 2018. We do see that overall yields have improved, suggesting the upward re-pricing of the back book due to increase in MCLR rates. The gradual rise in yields has led to a situation where spread between bank funding and bond rates have gradually started to converge.
Introduction of external benchmarks
RBI has asked banks to implement external-benchmark-based loan pricing for all floating rate personal, retail and MSME loans from FY2020 (final guidelines awaited). The appropriate benchmarks chosen are repo rate, T-bill (91/182 days) or any other benchmark produced by Financial Benchmarks India Pvt. Ltd (FBIL). The key concerns are: (1) Shift to external benchmarks for loan pricing will lead to greater volatility in spreads. NIM could come under sharp pressure during declining interest rates for low spread products like housing loans.
(2) A fixed cost liability franchise could result in banks lowering the duration to reduce volatility of NIM. The ability of banks to address this risk is not clear as they would need (a) retail floating rate deposits and (b) interest rate hedging products.
Edited extracts from Kotak Institutional Equities Research