Loan Growth, Fees to Lift Bank Profits in Q3, Higher Deposit Costs to Pinch

Understanding the Impact of Bank Dynamics on Investors and Industries

Source and citation: Loan Growth, Fees to Lift Bank Profits in Q3, Higher Deposit Costs to Pinch, ET Bureau, Economic Times, January 9, 2024

Analysis for Layman

Banks have been aggressively raising deposit interest rates to meet the surging demand for loans. However, the increase in lending rates has not kept pace with the deposit rate hikes. This disparity is affecting the net interest margin (NIM), which is the difference between the interest earned on loans and the interest paid on deposits. Lower NIMs can impact the core profitability of banks.

Despite this margin pressure, overall bank profits are expected to rise in Q3 due to robust loan growth, stable bad loans, and higher fees. Investors, however, need to closely monitor the margin situation going forward.

Loan Growth, Fees to Lift Bank Profits in Q3, Higher Deposit Costs to Pinch

Impact on Retail Investors

For investors, the margin squeeze presents challenges in the earnings outlook for bank stocks. Top lenders such as HDFC Bank, ICICI Bank, and Axis Bank may experience softer NIM guidance, potentially capping short-term stock upside.

However, the continued momentum in loan growth, particularly in mortgages, vehicles, and small business loans, contributes to overall profitability and secures long-term growth. Investors are advised to differentiate between margin weakness and business growth when analyzing results. Lenders gaining market share through distribution reach and digital initiatives may hold potential, emphasizing the importance of selectivity.

Rising deposit rates also benefit bank depositors, and investors are encouraged to consider placing some savings in 1-2 year bank fixed deposits to capitalize on improved returns.

Impact on Industries

Banks are likely to face margin pressure in the near term, impacting sentiment across banking and NBFC (Non-Banking Financial Company) stocks. Top lenders such as SBI, HDFC Bank, and ICICI Bank may guide conservatively on NIMs.

However, continued demand for retail loans benefits mortgage-focused HFCs (Housing Finance Companies) like HDFC and LIC Housing, despite some margin pressure from higher capital costs.

Growth in unsecured loans and credit cards also aids private banks and some NBFCs like Bajaj Finance. Market share gains are facilitated by their agility, although a watchful eye on bad loans is essential.

Insurance and mutual funds benefit from a wider financial savings mobilization as deposit rates influence asset allocation.

Long Term Benefits & Negatives

Over the long run, higher deposit rates have the potential to expand the formal financial savings base. As more households rely on bank deposits, the transmission of rate signals improves. Banks also gain a better understanding of depositors’ income stability, spending patterns, and cross-selling opportunities.

However, effective management of interest rate risks is crucial for banks across assets and liabilities. Those slow to adopt digital analytics may face margin pressure, emphasizing the compulsory need for technology investments.

Persistent margin pressure can induce risk appetite in credits, leading to loose lending standards and higher bad loans later. Banks need to strike a balanced profit focus between margins, fees, and volumes.

Short Term Benefits & Negatives

Over the next 2-3 quarters, core NIMs are expected to remain under pressure as deposit rate resets lag lending rates. Banks may guide cautiously on margins during this period.

However, higher credit costs are anticipated to be offset by balance sheet growth, particularly in mortgages, commercial vehicle finance, credit cards, and MSME loans.

Digital banks leveraging data analytics and platforms are poised to gain market share, capitalizing on lower operating costs. Investors may find opportunities to accumulate stocks of HDFC Bank, ICICI Bank, and Axis Bank during market corrections.

However, the potential risks of a global recession impacting IT/outsourcing, exports, and corporate capex plans could affect growth and asset quality. The key to banks’ resilience lies in effective risk control and early warning systems.

Potential Impact of Q3 Banking Earnings on Companies:

Indian Companies Likely to Gain:

  1. Private Banks: HDFC Bank, ICICI Bank, and Axis Bank could benefit from their strong retail loan focus, as retail segments remain resilient despite rising deposit costs. Their diversified income sources beyond net interest margins, like fees and wealth management, can further cushion their earnings.
  2. Small Finance Banks (SFBs): Companies like Bandhan Bank and AU Small Finance Bank might see sustained loan growth in their target segments, leading to improved profitability despite margin pressures. Their lower reliance on large deposits offers some insulation from rising costs.
  3. Housing Finance Companies (HFCs): HDFC and LIC Housing Finance could benefit from continued momentum in the home loan segment, especially with festive season demand potentially pushing loan disbursals. Lower mortgage rates compared to overall lending rates might mitigate margin compression.
  4. Non-Banking Financial Companies (NBFCs): Bajaj Finance and Capital First could see healthy growth in unsecured loans and vehicle finance, partially offsetting margin pressures. Their flexible funding mix and ability to adjust lending rates faster than banks might support profitability.

Indian Companies Likely to Face Pressure:

  1. Public Sector Banks (PSBs): SBI, Bank of Baroda, and PNB might face a sharper squeeze on margins due to their higher dependence on large deposits and challenges in raising lending rates due to government mandates. Their asset quality risks also need monitoring.
  2. Corporate Loan-Focused Banks: Yes Bank and RBL Bank, with heavier exposure to corporate loans, could be impacted by potential credit weakness in some sectors. Rising deposit costs coupled with sluggish corporate credit growth might further strain their profitability.
  3. Banks with High Leverage: IDBI Bank and UCO Bank could face greater challenges due to their already thin margins and higher dependence on wholesale funding. Rising deposit costs will likely disproportionately impact their profitability.

Global Companies Unlikely to Lose:

  1. Global Investment Banks: Companies like Goldman Sachs and Morgan Stanley might see potential opportunities in advising Indian banks on restructuring debt, managing treasury operations, and raising capital, benefiting from increased financial market activity.

Important Note: This analysis is based on the information provided in the news article and should not be considered financial advice. Please consult with a professional financial advisor before making any investment decisions.

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