It’s not just Mercedes, even bank deposits are competing with equities

• Sluggish growth in deposits is a major concern for banks, as higher rates are likely to impact margins in the near term.
  
  
• Kotak’s analysts have built in a negative thesis on the NIM outlook in the medium term.
  
  
• Race to hike term-deposit rates by public sector banks likely to impact return on assets and delay any re-rating.
  

Financialisation of household savings is expected to have a far-reaching impact on the banking sector. So far, banks have enjoyed the benefits of low-cost deposits as Indians kept their money with banks in the form of deposits. But with the equity cult going mainstream, banks are in for a choppy ride. Bank stocks have been rallying for the last several weeks, as credit growth is picking up pace and profitability has been robust.

But there’s a problem: the pace of credit growth is way slower than deposit growth. This essentially means that Indians are either drawing money from banks to spend or are redeploying funds to other asset classes. What this essentially implies is that banks will have to increase deposit rates even further if they wish to convince depositors to park their monies with them. This is a risk that institutional investors are now worried about as higher deposit rates could impact the net interest margins of lenders. In a bid to attract stable longer-term deposits, many banks are offering interest rates of 7% even. Many analysts believe that this may trigger a competition between banks to attract more deposits.

According to Kotak Institutional Equities, “It is perhaps reasonable to conclude that depositors are drawing down on their excess savings or changing the nature of their savings.” And higher interest rates are unlikely to change this behaviour as the historical relationship between interest rates and growth is not strong, claim analysts.

According to a report by Kotak Institutional Equities, banks have increased their interest rates on deposits and are currently comfortable, as their loans are re-pricing higher. But it has a more open ended approach to NIMs (net interest margins). Kotak’s analysts have built in a negative thesis on the NIM outlook in the medium term, but they say that several variables can change this.

So what is making analysts nervous? Well it isn’t just Mercedes that is facing competition from systematic investment plans of retail investors through which retail investors are putting chunks of their savings into equity-oriented mutual funds. Bank deposits are no longer as popular with Indians as they used to be. After being flush with surplus savings that Indians could not spend during the pandemic, deposit growth is lagging loan growth.

Recent data shows that while deposits are growing at roughly 10% year-on-year, there is deceleration in current and savings account deposit growth. In contrast credit growth stands at 17%. What is, however, growing fast are the term deposit growth, which are more expensive as banks have to pay a higher interest rate on these than the money that sits in savings accounts and current accounts. Worryingly, deposits are decelerating in the metro and urban markets. According to Kotak, deposit growth could recover from current levels, but the drivers are still not that clear. In the interim, expect a reasonably competitive environment where banks continuously re-price their deposits higher.

The best source of term deposits for banks are the metro markets. According to Kotak, the metropolitan market accounts for 60% of the overall term deposit book, and growth has touched 12% annually, which is the best in recent years. The breadth of recovery is not uniform after the pandemic. While Western India (which accounts for 30% of term deposits) has grown at the fastest pace, the South is weak on term deposits as well as CASA.

When loans are being deployed faster than deposits are coming in, the ratio of loans to deposits goes for a toss. Currently, the LDR (loan to deposit ratio) for public sector banks is at 68% while it is at 88% for private sector banks. Public sector banks are already in a race to lower lending rates and hike deposit rates to corner more market share from private banks. However, this will impact their spreads – the difference between the interest rates they get from borrowers and what they pay to depositors – over the near-term.

According to Jefferies, “Despite having lower loan to deposit ratio, PSU banks have materially raised term deposit rates in the 2 year bucket. We believe this reflects their softer deposit growth (8% YoY vs. 9% for sector and 13% for private banks) and potentially their view that liquidity may stay tighter for some time.” While capitalisation and asset quality of public sector banks have improved, their return on assets continues to be between 0.6-0.8%, but intense competition to attract deposits could impact returns of public sector banks.

Shares of most public sector banks have rallied since the September quarter numbers as their performance was solid. However, going forward higher costs could eat into their profitability, thereby, preventing a re-rating. Jefferies further says: “Select banks are offering 7% interest rates for 2yr deposit rates. We believe that PNB's strategy of offering higher term deposit rates and lower lending rates could be a drag on spreads.”

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