February 8, 2023
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BFSI | New normal rate cycle; brace for transmission effects

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Signalling its serious intent to rein in a galloping inflation, the RBI announced a 50bps repo rate hike in its monetary policy meeting, close on the heels of its out-of-turn 40bps rate hike last month. Although the financial services sector has witnessed multiple interest rate cycles in the past, we argue that this rate hike cycle is different on account of a) accelerated nature of policy rate hikes (90bps within a span of 30 days); and b) loan pricing regime (mix of loan book linked to external benchmark with shorter resets). Unlike in the past, banks are likely to witness margin accretion during this stage of the up-cycle, given a near[1]complete pass-through on the asset side of the balance sheet thus far. However, the margin-pop is likely to be short-lived (next couple of quarters) with the pace of asset-side transmission gradually diminishing and lagged re-pricing of deposits. We identify ICICIBC (67% of loan book) and SBIN (75% of loan book) as best placed to capitalise on this stage of the rate cycle.

Accelerated rate hike; more in the offing: In its response to a stubborn and elevated inflation print, the RBI has now effected an accelerated cumulative 90bps repo rate hike over the past few weeks. Concomitant with a 50bps CRR hike and the withdrawal of a hitherto-accommodative policy stance, we expect the pace of policy rate normalisation to continue.

Near-total pass-through a surprise; near-term margin-accretive: Unlike earlier up-cycles in the past, the sharp pace of rate normalisation is margin[1]accretive for banks in the near-term, especially given early-stage monetary transmission. Nudged by the RBI, banks have gradually migrated their lending portfolios towards EBLR-linked loans (externally benchmarked lending rates) with ~40% of loans across retail segments anchored to the repo rate. Leading private banks have 35-50% of their loan book currently linked to EBLR, with a 3-month reset clause.

MCLR transmission to significantly lag EBLR transmission: At a system[1]wide level, ~20-30% of the aggregate loans are currently anchored to MCLR while 40% of the loans are anchored to EBLR. Given the sheer pace of rate normalisation, we expect transmission on the MCLR book to significantly lag transmission on the EBLR portfolio, both in terms of the quantum (extent of pass-through) and timing (EBLR will be more immediate).

MSME and housing portfolios likely to reflate fastest: Given the mix of pricing regime across asset classes and the likely sequence of transmission, we expect asset yields in MSME (70% EBLR linked) and housing portfolios (60% EBLR linked) to reflate the fastest and more quickly compared to the rest of the portfolios. However, given these are crowded segments, the pass[1]through is likely to incrementally diminish through the up-cycle on account of the competitive intensity in these categories.

Lagged deposit-side re-pricing: The re-pricing of the deposit side of the balance sheet is likely to happen gradually, given the surplus liquidity in the system and healthy C/D ratios. Banks have raised their term deposit pricing by ~10-25bps over the past few months, which is likely to gradually reflect in the incremental cost of funds for the banking system.

ICICIBC and SBIN best levered to up-cycle: We identify ICICIBC (48% EBLR; 22% MCLR for the domestic loan book) and SBIN (34% EBLR; 41% MCLR) as best positioned to capitalise on this stage of the rate cycle.

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