>BANKING SECTOR: Liquidity is likely to continue to remain stretched until August 2010

(1) scheduled issuances; (2) gradual inflow via government spending; and (3) slow deposit accretion. We believe rising wholesale rates are a precursor to the imminent increase in retail deposit rates (earlier than expectations). Banks highly dependent on wholesale funds (Yes Bank, IndusInd Bank), and NBFCs, could witness pressure on cost of funds. However given the effective transmission via base rate and emergence of pricing power amidst tight liquidity and pick up in credit offtake will positively impact margins.

■ Liquidity to remain tight unless buoyed by strong deposit growth and increased government spending: Considering the government issuance (Gsec, T-Bills, SDL) calendar and scheduled maturity, and interest due for these instruments, we estimate incremental outflows of ~INR 230 bn over next eight weeks. This is over and above the current repo of INR 568 bn (though redemption of INR 305 bn of Gsecs on July 28 will provide comfort). Post August, advance tax outflow in September and uptick in credit offtake before festive season will keep liquidity under pressure.

■ Wholesale rates rising sharply; retail to follow suit: Tight liquidity has created pressure on short-term rates; 3-month CP/CD rates are up 150-200bps, to 6% plus levels, and yield curve has started flattening. We believe repo rate hike and current tight liquidity scenario (to prevail for few more weeks) will aggravate pressure on wholesale rates. The trend in deposit mobilisation has not been so encouraging YTD; tight liquidity and rise in wholesale funds will pressurise banks to increase the retail deposit rates sooner than later.

■ NIMs unlikely to come under pressure soon over the medium term
We believe banks having higher dependence on wholesale funds viz Yes Bank, IndusInd Bank or higher proportion of deposits maturing within six months (adjusting for core CASA) viz ING Vysya Bank, Oriental Bank of Commerce, Kotak Mahindra Bank, and Yes Bank could witness relatively higher pressure on cost of funds. Over the medium term, however, we expect trend in bank margins to be positive, considering effective transmission of rise in deposit cost via base rate and enhanced pricing power amidst tight liquidity and pick-up in credit offtake. As per our recent interactions with NBFCs, most of them have started witnessing increase in funding cost due to rise in wholesale cost (CPs). On analysing the asset-liability maturity profile, we understand that there is no significant mismatch for NBFCs in the near term that can impact their margins adversely. For HDFC and LIC Housing Finance, assets and liabilities maturing within one year are matched effectively; M&M Financial, Magma and Shriram City Union have more assets maturing within one year than liabilities. While in case of PFC and REC, proportion of liabilities maturing in one year is higher than assets, we believe the asset-liability structure (above 80% liabilities fixed and more than 70% assets floating), coupled with pricing power should support margins.

To read the full report: BANKING SECTOR