Impact of Rising Deposit Rates on Banking and Investors
Source and Citation: Original reporting from unnamed author via ET Bureau, published January 5, 2024.
Analysis for a Layman
Banks play a crucial role in the economy by lending money collected from customer deposits. As the economy recovers from the pandemic, there is a surge in loan demand from individuals and businesses. However, the liquidity, or the money that banks have available for lending from customer deposits, is decreasing.
Competition for Deposits
To meet the credit growth target of 15-17%, banks are fiercely competing for deposits. This competition, coupled with factors like market uncertainty and the central bank’s reluctance to cut interest rates, is leading to an increase in deposit rates.
Impact on Retail Investors
For retail fixed income investors or savers, the prolonged high deposit rate environment is advantageous. Existing bank Fixed Deposits (FDs) get repriced higher upon renewal, and fresh deposits offer elevated returns for 1-5 years. This is particularly beneficial for conservative seniors and risk-averse investors seeking fixed regular income.
Diverse Investment Options
Apart from FDs, small savings schemes, company deposits, debentures, etc., also offer attractive rates, providing investors with flexibility and bargaining power. Special bucket rates for short-term surpluses further enhance the benefits for retail depositors.
Impact on Industries
Double-Edged Sword for Banks
While higher savings inflows allow banks to maintain growth in loans and improve asset quality, paying higher costs for deposits affects margins. Banks may face challenges in maintaining loan pricing competitiveness on thin margins, with state-run banks having a slight edge due to lower costs.
Industry-Wide Impact
The banking sector experiences a reduction in profitability after years of repairs, with rising cost-income ratios and a tapering off of Return on Assets and Equity. Teams are under stress to generate volumes, ensure risk controls, and maintain service quality. Constant innovation is essential to ease funding pressures via affordable capital alternatives.
Long Term Benefits & Negatives
Building Stable Funding Base
Over the long term, sustained high deposit rates benefit banks by expanding India’s household savings and building a stable, low-cost funding base. Today’s rate hikes may become tomorrow’s low-cost funds at repayment, aiding financial inclusion goals and reducing dependence on volatile capital market liquidity.
Challenges in Asset-Liability Management
However, there are risks of asset-liability mismanagement, leaving banks with high-cost legacy funds if liquidity eases in the future. Slower branch expansion, digitization, and product development amid margin pressures may hinder growth.
Short Term Benefits & Negatives
Positive for Savers
In the short term, savers benefit from attractive deposit rates, with banks raising rates in a planned manner. Relatively modest hikes leave room for further increases if liquidity tightness persists.
Pressured Margins
Despite the benefits for savers, pressured margins are visible in some lenders’ quarterly performances. Analysts expect this trend to continue for a few quarters, potentially impacting bank stocks.
Impact on Credit Growth
Pricing power reduction on some loan products may slow credit growth on the margins if rates rise too fast. Small finance banks and NBFCs face greater deposit competition from big banks.
In conclusion, while the banking sector may face short-term challenges, the extended high rate environment is poised to benefit India’s savers the most.
Impact of Rising FD Rates on Indian Companies:
While pinpointing individual companies is not entirely accurate due to limited information, we can analyze potential impacts on broad categories based on the news:
Indian Companies:
Gaining:
- Banks with Strong Deposit Base: Banks like HDFC Bank, Kotak Mahindra Bank, and ICICI Bank, known for their robust deposit franchises, are well-positioned to enjoy higher margins despite rising deposit rates. They can leverage their existing customer base and brand reputation to attract deposits at relatively lower costs compared to competitors.
- Retail-focused NBFCs: Companies like Bajaj Finance, HDFC Finance, and LIC Housing Finance, dependent on retail deposits for funding, stand to benefit from higher FD rates. This could improve their access to cheaper funds and potentially lower their lending rates, making them more competitive in the loan market.
- Fixed-income Mutual Funds: Increased interest rates on FDs could lead to greater investor interest in fixed-income mutual funds, particularly those focusing on short-term investments. Funds like ICICI Pru Cash Management Fund, HDFC Cash Management Fund, and Franklin Templeton Short Term Debt Fund could see higher inflows.
Losing:
- Public Sector Banks (PSBs): With already tight margins and higher dependence on bulk deposits, PSBs like SBI, PNB, and Bank of Baroda might face further pressure from rising FD rates. Increased funding costs could potentially impact their lending rates and profitability.
- Infrastructure and Capital Goods Companies: Higher borrowing costs for banks due to rising deposit rates could translate into potentially higher loan rates for infrastructure projects. This might lead to slower execution of projects and impact companies like Larsen & Toubro, KEC International, and ABB India.
- Real Estate Developers: Rising interest rates across the board could discourage borrowing for both developers and homebuyers, potentially impacting property sales and slowing down the real estate sector. Companies like DLF, Godrej Properties, and Oberoi Realty might face subdued demand and slower growth.
Market Sentiment:
- Overall, the news of rising FD rates could have a mixed impact on the Indian market. Sectors like banking and NBFCs might see positive sentiment due to improved profitability, while PSBs, infrastructure, and real estate could face headwinds.
- Investor sentiment towards interest-rate sensitive sectors will likely turn cautious, leading to potential profit-booking and volatility in their stock prices.
Please note: This analysis is based on the provided information and should not be considered financial advice. Always conduct your own research and consult with a qualified financial professional before making any investment decisions.