Kotak,IndusInd: When easy money ends
Lack of liquidity could precipitate corporate asset quality problems.
RBI in an attempt to protect the rupee announced a reversal in its easy money stance: In a surprise move,RBI has announced a 200 bp hike in bank rate to 10.25,sucking out R120 bn of liquidity through OMOs open market operations.
It has capped banks borrowing under the LAF liquidity adjustment facility repo window at 7.25 to R750 bn,and for any incremental liquidity,banks will have to source funding at the now elevated bank rate of 10.25. The measures are aimed at drying up excess rupee liquidity in an attempt to reverse the slide in the currency.
Banks asset growth had outpaced deposit growth: Though the banking system deposit growth fell short of the loan growth and the government’s borrowing needs were large,this didnt strain system liquidity and domestic rates continued to be relatively low.
Comforted by the central banks easy money stance,Indian banks loan growth was consistently running ahead of deposit growth for the past three years. The current moves should drive a spike in both short-term rates and bond yields.
Banks have been regularly borrowing R800 bn-R1.2 trillion from the repo window over the past few months,as deposit growth has been lagging loan growth. We expect short-term rates that were hovering close to repo rates at 7.25-7.5 to spike. Long-tenure bond yields should also move up significantly,particularly as the RBI has simultaneously announced R120 bn of treasury sales sterilisation.
Loan deposit ratios were also consistently rising,and at 78,are at a historic high. Customer assets-to-deposits ratios for most banks are in excess of 80 despite the 27 reserve requirement for Indian banks. Increasing ALM mismatch aggravates the problem: ALM asset-liability management mismatches at some of the banks had also aggravated over the past couple of years,as loan book tenures had been rising.
Many banks had also tactically cut the duration of their liabilities as they were positioning themselves for rate cuts.
Downgrade high-valuation,wholesale-funded banks: The wholesale-funded entities Yes,Kotak,IndusInd and the NBFCs with high LDRs loan-deposit ratio and those with ALM mismatches will be the worst impacted with these moves as they will be forced to curb asset growth in addition to facing margin pressures.
Earnings at banks with large sensitivity to bond portfolios MTMmark-to-market SBI,BOI,Axis and Yes will also be vulnerable. Indian bank valuations till now were primarily determined by asset side comfort. As the liability part of the balance sheet also comes into focus,stocks of retail banks like Kotak 95 LDR and IndusInd 82 trading at 3x book will see downside,and we downgrade these two to Underperform from Neutral.
Will this precipitate asset quality issues? The biggest risk from these set of measures would be if the lack of liquidity precipitates the corporate asset quality problems. Corporate asset quality issues are being understated by banks continuing to roll over debt. As this becomes difficult/ pricey with the lack of liquidity,some of these assets may turn to NPLs non-performing loans on banks books quicker than expected. We maintain our Underweight stance on the Indian banks sector.
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