CREDIT POLICY POSITIVE FOR BANKS

A cut in RBI's policy rate was widely expected, but the quantum of repo rate cut came as a surprise to the market.

The cut in repo rate, the rate at which the banks borrow from RBI, will prompt banks to in turn reduce their lending rates.

A cut in lending rates may not only revive the credit off-take, but also partly allay the asset quality concerns for banks. The margins of the banks may also improve as the cost of borrowing comes down.

STOCKS RISE

While banking stocks reacted positively, given the neutral stance of RBI on further rate cuts, the gains were limited. Going by the Overnight Index Swap, the market is discounting another 25 basis point decline in rates over the next one year.

The public sector banks with a higher exposure to government securities may benefit from price gains on their books. However, the fall in rates will help smaller private banks which rely more on bulk deposits, immediately save on cost of funds.

Rates on certificate of deposit are already down from 11.5 per cent to 9.2 per cent in less than 20 days following the liquidity pressures partly receding and also reacting to the rate cut.

IMPROVEMENT IN MARGINS

Banks may choose to pass on the entire rate cut to their clients to stimulate offtake. Banks hiked lending rates by 180 basis points during the last fiscal, according to the RBI, in line with 175 basis points hike in its repo rate. The marginal fall in cost of funds due to release of cash reserve ratio may also prompt a cut in lending rates once liquidity eases.

Banks, whose margins have positively benefitted by close to 10 basis points due to the cut in the reserve ratio, may further see their margins improve due to fall in repo rates.

For one, the deposit rates tend to fall ahead of lending rates. Secondly, given that yields on investments are sticky, this will positively impact the margins.

ASSET QUALITY TO IMPROVE

Lower rates will also provide some relief to banking sector on rising bad debts. As of December 2011, the gross NPA ratio of all listed banks was 2.8 per cent which is likely to have risen by March.

The RBI notes that, as of March 2011, corporate sector had an interest to profits ratio of 20 per cent. This rose to 25 per cent by September 2011. Weakening demand could further push up the ratio. Given the significant impact of interest costs on profits, a rate cut may lower the interest outgo and revive the asset quality cycle of banks.

With RBI projecting slightly higher GDP growth (7.3 per cent) than last fiscal, the top-line growth may also marginally revive for the corporate sector.

SOURCE: http://www.thehindubusinessline.com/industry-and-economy/banking/article3324539.ece