>RBI Raises CRR by 75 bps – Impact on Indian Banks (MORGAN STANLEY)

Quick Comment: The Reserve Bank of India has raised the cash reserve ratio (CRR) by 75 bps. The policy interest rates – reverse repo and repo rates – have been left unchanged at 3.25% and 4.75%, respectively.

In our view, the direct impact of this move is that NIMs for banks will be impacted by about 5 bps, implying a F2011 earnings impact of 3-4% for banks in our coverage (assuming all else is equal). In our estimates, we had factored in a 100 bps rise in CRR through the coming year.

Move would absorb a part of the excess liquidity in the banking system: We estimate the CRR hike will absorb about Rs360 bn (US$7.7 bn) – implying that about 20-25% of the excess liquidity with the banks will be absorbed. This excess liquidity was so far being parked by banks at the shorter end of the yield curve.

Yield curve should start flattening: The RBI move is likely to cause short rates in India to start moving up, in our view. This could act as a cushion for banks as although they will lose interest on the liquidity taken up by the CRR hike (wherein they have earnt no interest) -- the interest that they will earn on the balance excess liquidity will go up.

RBI moving to tightening mode could reverse credit disintermediation: Further, a rise in short rates could reverse some of the credit demand that has been disintermediated by the commercial paper market.

Remain positive on Indian banks: As we highlighted in our recent note – “Rising Rates & Banks Stock Performance”, dated January 25, 2010 – history suggests that banking stocks could underperform in the period following the first tightening move. However, we would be buyers on dips given that: a) fundamentally, the negative impact of rate hikes should be materially lower this time around; and b) we believe a gradual rise in rates will be good for earnings progression, as it would support margin expansion for Indian banks.

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