Sumit Aggarwal How Rate Cut Will Impact Banking Sector Margins and CASA Ratio

“A few years ago, we had a CASA peak somewhere in the mid-40s, 44-45% for most major banks, including private and public. But today we are somewhere in the late 30s or early 40s and so if the rate cut , it will not immediately lead to repricing on the deposit side,” says Sumit Aggarwal, Bandhan AMC.

How do you see what the outlook might be in terms of margins for some of the banking counters behind this?
Sumit Aggarwal: If you look at over 50% of most banks’ book tied to external benchmarks at the moment, that’s something that is priced in within about a month of the first rate cut.

And on the deposit side, we must keep in mind that the CASA ratio of most banks today is not what it was a few years ago.

A few years ago, we had a CASA peak somewhere in the mid-40s, 44-45% for most major banks, including private and public. But today we are somewhere in the late 30s or early 40s and so even if the rate comes down, it will not immediately lead to repricing on the deposit side.

And at the same time, if you look, you also have to look at the short tenure portion of the deposits, which is on the bank’s deposit book.

Let’s say something or the deposits mature in, let’s say, six to nine months and if you look at the share of those deposits, maybe the private sector banks score well here because they have a slightly longer duration of deposits that mature in six to nine months. . months and hence, it can be recovered in about two to three quarters which will help in reducing the additional cost of deposits.

So, in a way, they have more of a cushion to protect their margins. And while I agree that PSU banks, they may have a higher MCLR linked loan book, but at the same time on the deposit side they somehow have slightly longer term deposits, so it will take a little longer to reprice their deposit book.

And so, in brief, we have to go through each bank case by case to see who will be better protected. But overall, I think probably the private sector banks will be in a better position at least from the deposit pricing side of view.

Just want to understand how you approach the banking sector right now? I mean, are you saying that maybe banks with high fixed loans are going to get cushioned because we were just chatting with Sunil Mehta of IBA and he was saying that’s not the case because as a percentage, the floating rate is that way. . More than fixed loan rates.
Sumit Aggarwal: Yes, that’s right. So, the fixed rate, the data you presented, is somewhere between 70% and 20%. But EBLR-linked loans are around 50%. So, the way we should proceed, especially from a portfolio management perspective, is to go with the time-tested method of respecting valuations and then marrying them to fundamentals. So, if you see, probably, the private sector banks are trading at better valuations compared to their past history. And PSU banks have done very well in the last three years, especially post-Covid.

And today, if you look at their ROA or even their cost to book valuation, they are at a long-term level of around 1% ROA and around 1% to book against private sector peers who are actually earning at least 70 to 80 -1.2 times the cost. Basis point higher ROA and lower leverage, giving them equivalent ROE.

So, in that context, playing the portfolio, I would say that we should probably be more inclined towards some larger exposures with the private sector peers and be selective on the public sector side as a whole from a portfolio management point of view.

What is the outlook when it comes to treasury valuations as we were discussing with Mr. Sunil Mehta, he said that a rate cut could potentially impact treasury valuations. Is it something you are expecting?g too?
Sumit Aggarwal: See, in general, when the rate cycle turns upside down or down, Treasury valuations are affected because the market has traces of losses and gains accordingly.

So, if we enter a rate cut cycle soon, there will obviously be some impact on the mark-to-market on banks’ treasury books. But we have to keep in mind that, in previous cycles, banks had a lot of NPAs and very smartly some of the treasury profits were actually used to provide for those bad loans.

But today asset quality is quite healthy for banks. So, while on MTM you will have some sort of maybe positive impact, but on the accrual side obviously the 10-year is already materially down. So, you will have additional less earnings on the other income side.

But I think this is all part of the banking cycle and we have seen many cycles like this. So, accordingly, the focus should be on what affects ROA and currently ROA seems safe for the banking system as currently there is no material impact on asset quality and the risk to margins is the same as all of us. As we are discussing now, it seems quite organized.

In the near term, there may be a case that more NBFCs do better than banks because they actually borrow from the wholesale market and the implication for the wholesale borrower, both in terms of near term profitability. Move and may actually be more in terms of demand. So, is there a case for NBFCs to outperform before banks start outperforming?
Sumit Aggarwal: Yes, I totally agree with that. In fact, we have seen this every time the rate cycle really turns and the nature of NBFCs, most of them being high on fixed loan sizes like vehicle financiers, they perform well because most of them don’t take deposits and the cost of deposits is any part of the system. is way high. So, you resort to bulk funding or CD issuances or some of those types of borrowing and that market is already down in terms of cost of money.

So, the spread you earn on NBFC book is more predictably higher as compared to bank where we are almost debating whether it will be good or bad. But for NBFCs, I think it is quite clear that the spread should actually be better.

In a way that will also be reflected in the stock price performance as it has always been in the past. And in some ways also reflected in the performance of the sector as a whole in the recent month or two.

Now, if one looks at, let’s say interest rates come down, but what happens to the liability problem because that is not addressed. If interest rates come down, only the cost of deposits will go down and that’s it to make This complete shift of savings to stock market or savings to insurance is somewhat more and less attractive to bank depositors. So, the elephant in the room is not addressed. When we assume that Rates are down, banks will do well, the problem is something else.
Sumit Aggarwal: No, fair point. I think we are discussing the entire flow of money out of the banking system into the stock markets. But somehow the spread you get on deposits compared to G-Sec was historically much higher. And in fact, if you look at the current, the last year or two, that spread has actually narrowed. So, while obviously the type of investor is very different for a stock market and FD investor, but still you should have some meaningful spread on G-Sec to attract deposits from an investor’s point of view.

I take that point, but in a way, banks are also resorting to issuing a lot of CDs. For example, if retail is not growing, retail deposits are under pressure, if you look at the type of CDs that banks have issued in the last six months, it is very high.

So, these kinds of things happen all the time. Sometimes CDs become cheaper. Sometimes NCDs become cheaper. And sometimes real deposits get cheaper too.

We will have to see how it goes. And at the same time, as you rightly said, behaviorally, the feeling is that a lot of savings are flowing into the markets.

And if the markets on margin start giving you a bit less returns and delta and FD returns also start shrinking compared to the market returns, possibly the behavior pattern may also change a bit.
But as we see today, deposits are growing at only eleven percent and credit at around 14%. This is about 3% lead lag. And if this continues for some time, I’m a little bit wary if the deposits don’t improve, then the loan growth might take a bit of a hit as we end the year. So, right now, we are all making around 14-15%.

But if this whole unsecured loan and deposit pressure continues, we may slip another 100-150 basis points and grow at 13-13.5% against 14-14.5%. And in that scenario, maybe PSU banks might not do well because let’s face it they are a bit over leveraged.

For about 80 bps lower ROA, they generate similar ROA as compared to private sector banks. And if the credit growth at the margin comes down, the ROE will actually come from a higher margin for them and that’s why I have a bit of a cautious view on PSU banks from that perspective.