Synopsis: This article delves into the outlook on India's banking sector amidst potential monetary policy adjustments, specifically the likely rate cuts and their impact on banks such as HDFC Bank and ICICI Bank. BNP Paribas Analyst Santanu Chakrabarti shares insights into the prospects for rate cuts by the Reserve Bank of India (RBI), how these cuts may affect bank margins and the broader implications for banks and non-banking financial companies (NBFCs).
The Monetary Policy Outlook and Its Impact on Banks:
India is witnessing relatively benign headline inflation, despite persistent inflationary pressures in specific pockets like vegetable prices.
However, these inflation pockets are unlikely to be significantly influenced by monetary policy adjustments.
This has led experts, including BNP Paribas' Santanu Chakrabarti, to predict a likely 50 basis points (bps) rate cut over the next six months, starting with a 25 bps reduction in December.
Several factors reinforce this forecast, including the recent rate cut by the U.S. Federal Reserve and the Reserve Bank of India's shift from a "withdrawal of accommodation" to a "neutral" stance.
Additionally, the RBI's increased tolerance for greater overnight liquidity without offsetting Open Market Operations (OMOs) supports this view.
Impact of Rate Cuts on Bank Margins:
Rate cuts exert immediate pressure on bank margins, as the asset side of the balance sheet (loans) adjusts more quickly than the liability side (deposits).
For instance, repo-linked loans, such as mortgages and prime corporate loans, experience near-instantaneous pricing adjustments, squeezing the net interest margins (NIMs) of banks.
However, this short-term pressure on margins is not the whole picture.
Rate cuts lay the foundation for potential margin expansion, especially as the cost of funds begins to ease.
This could come from the repricing of fixed deposits (FDs) and higher momentum in CASA (current and savings account) deposits.
These effects, though gradual, are expected to support bank margins by FY26.
NBFCs may initially seem better positioned than banks when rate cuts are introduced, primarily because they typically hold more fixed-rate assets.
Yet, the immediate impact on earnings for both banks and NBFCs is estimated to be limited (about 3-6%).
Earnings Outlook for Indian Banks in FY25:
For the second quarter of FY25, analysts expect stability or a slight decline in bank margins, but nothing too drastic.
Margins should be supported by term deposit repricing to market rates and reduced short-term borrowing costs.
In addition, data on system-level credit growth shows a minor slowdown, while deposit growth has picked up, particularly in fixed deposits.
As a result, this earnings season should mark a low point for year-on-year growth for most banks, with FY26 expected to usher in more stability.
Large-Cap Bank Stocks in FY26:
The analyst projects a benign margin expansion for large-cap banks in FY26, driven by strong credit growth and the stabilization of net interest margins.
This environment should provide a re-rating catalyst, with HDFC Bank, ICICI Bank, and Axis Bank emerging as top picks for strong performance.
Kotak Mahindra and City Union Bank are expected to underperform in comparison.
HDFC Bank vs. ICICI Bank: Who Has More Re-Rating Potential??
HDFC Bank is seen as having more re-rating potential than ICICI Bank at current prices.
Despite ICICI Bank's strong performance and its movement toward steady-state valuation multiples, HDFC Bank's lower valuation offers greater upside.
Additionally, HDFC Bank stands to benefit from the post-merger balance sheet and the expiration of high-cost non-convertible debentures (NCDs) and fixed deposits (FDs) it inherited from its parent entity.
This should help HDFC Bank's return on assets (RoAs) gradually recover toward 2% and drive favourable comparisons to its pre-merger averages, setting the stage for further valuation improvements.
In conclusion, India's banking sector is poised for changes as the likelihood of rate cuts looms, creating a complex environment for both banks and NBFCs.
Although the initial impact may be challenging for bank margins, the long-term outlook remains optimistic, particularly for large-cap banks like HDFC Bank, ICICI Bank, and Axis Bank.
HDFC Bank, in particular, has significant re-rating potential due to its post-merger synergies and relatively lower valuation, setting it up as a standout performer in the coming years.
Disclaimer: The information provided in this article is for educational and informational purposes only. It does not constitute financial advice. Please consult with a qualified financial advisor before making any investment decisions. The analysis and opinions expressed in the article are based on current market conditions and are subject to change.
