BANKS MAY FACE MARGIN PRESSURE, EVEN AS LENDING REVS UP

The dream run that banking stocks have enjoyed over the last couple of years may not continue next year, even as lending to companies revs up.

Apart from the fact that stock valuations have climbed significantly, margin pressures, low treasury income, higher provisioning for asset quality and pension liability (in case of public sector banks), are expected to exert pressure on bank profits. With the infrastructure exposure of banks also nearing its maximum limit, some banks may even be forced to miss out on a part of the credit growth opportunity.

Competition is also set to heat up, as new bank licenses are expected to be handed out, albeit with high entry barriers. If inflationary pressures do not subside, further monetary tightening may also put pressure on bank margins.

Private banks to score

Private banks' stocks, which lagged public sector banks (PSBs) in terms of returns, are expected to do better this time around. Private banks enjoy strong fee income base, have low proportion of restructured loans and no AS-15 (pension liability) burden.

This will place them at an advantage to PSBs in 2011, even as all banks may have to contend with margin pressures. Select old private banks may also outperform on the back of consolidation and M&A activity.

Over the last one year, banks, apart from dealing with monetary tightening which increased borrowing costs and sucked out the liquidity, had other problems, too.

Asset quality slippages, especially from restructured assets, increased provisioning (asset quality and mark-to-market). Implementation of base rate paving way for disintermediation had also taken a toll on their business. Despite these negatives, banks were able to tide over unscathed as the margins expanded.

However, during December quarter, there are signs of the re-pricing effect of deposits beginning to wane, even as deposit inflows started to dry up. Additionally, concerns over microfinance and telecom exposure, loan bribery cases also pulled down the stock prices of banks. Over the past year, the majority of PSBs got capital infusion with Government pumping in more capital than promised in the Budget. The Government has till date provided Rs 21,000-crore equity, as against the budgeted Rs 16,500 crore.

Capital support may continue next year also, as SBI, Central Bank of India and UCO Bank are expected to come up with their rights issues. These infusions will support strong rate of credit growth.

Credit growth, currently at 23 per cent, as against RBI's March 2011 projection of 20 per cent, is indicative of the improving business outlook. With GDP expected to grow at 8.6 per cent during the current fiscal and may go up to 9 per cent the next, the banking sector may continue to witness sustained demand for credit. Improved fiscal outlook next year would also help banks focus on corporate loans.

However, while the credit growth has been very encouraging, it is deposit growth which continues to be a concern, deposit growth rate was 15 per cent as against RBI projection of 18 per cent.

According to RBI, as of March 2010, 49 per cent of the deposits in the banking system had a residual maturity of less than one year. Assuming the majority of the incremental deposits also have been shorter term deposits their re-pricing at lower rates has already happened. Therefore, incremental cost of funds may create margin pressures.

Risks to margins

Lending rates have been lagging deposit rate hikes, probably due to shift to market borrowings and high competition. The fall in credit-deposit ratio from current levels of 74.3 per cent also poses risks to margins. The current ratio is stiff and may come back to 70 per cent in the long-term.

SOURCE: http://www.thehindubusinessline.com/2010/12/28/stories/2010122850770600.htm