Beyond banks' Q3 earnings: Concerns over deposits, margins and credit growth

Each bank has adopted different approaches to gain customer share and deposit share, in their ‘race for deposits’.

India’s largest private sector lender HDFC Bank’s stock lost 11.2 percent in the past two trading days at the stock markets, dragging with it the Nifty Bank index by five percent and the overall stock markets by 2.58 percent. A range of factors, including flat margins at 3.4 percent for the bank, a significant drawing down of the LCR [liquidity coverage ratio] and loans outpacing deposit growth, resulting in a high credit to deposit (CD) ratio, have hurt the near-term earnings outlook for HDFC Bank, pushing the stock down 13.2 percent in 2024.

The Bank’s CASA (Current and Savings Account) ratio has also come under pressure post the mega-merger with HDFC, down to 37.9 percent in the December-ended quarter from 44 percent for the corresponding quarter a year earlier. This was the impact of term deposits added to the base.  

None of this data was unexpected or unknown. The pressure driving the stock down appears to be driven by the tone of the management. It reflects that these issues will take some time to correct.

With at least 12 banks, most commercial and some small finance banks, set to announce their quarterly earnings over the next week, are some of them likely to face similar concerns that HDFC Bank did? HDFC Bank is dealing with issues involving the merger, but some issues such as the difficulties surrounding building deposit growth are being faced by most of the banking ecosystem.

HDFC Bank’s loan book grew 3.8 percent quarter-on-quarter to around Rs 25,271 billion for Q3FY24, while deposits rose by 1.9 percent to Rs 22,140 billion, for the corresponding period. As a result, the CD (credit to deposit) ratio for the merged entity increased to 110 percent in 3QFY24. The RBI has not mandated a specific CD ratio level but would be happier with something around the 80 level.

Kotak Mahindra Bank (KMB), set to announce its Q3 earnings on January 20, has seen a 7.4 percent decline in its stock price since December 28. Experts believe that if a bank offers—which KMB has been doing—a differential interest rate on savings accounts products, it might be struggling to gain deposits. KMB offers a 4 percent annual interest on its 811 digital savings account, a fixed deposit type interest rate of up to 7 percent on its ActivMoney account launched in June 2023 and a 4 percent interest on its Ace Savings account for balances above Rs 50 lakh.

The Kotak ActivMoney account amalgamates the benefits of a savings account and a fixed deposit account. The account automatically creates an FD when your savings account balance exceeds a predetermined threshold.  

KMB has been seeing a strong deposit growth, but its cost of funds has been rising too, which will impact net interest margins. Analyst Jai Prakash Mundra of ICICI Securities in a January 8 report had said that “continued re-pricing in term deposits and higher share of term deposits within incremental deposits should sustain upward pressure on cost of deposits. Overall, we see 5-15 basis points quarter on quarter dip in net interest margins (NIM), with highest impact on Kotak Mahindra Bank (15 bps) followed by Axis Bank, Karur Vysya Bank, South Indian Bank and DCB.  

South Indian Bank, which reported its Q3FY24 results on Thursday, has seen a 184 percent surge in net profit in sequential quarters ending December 2023. But its net interest income has declined 1 percent to Rs 819 crore in Q3FY24 from Rs 830 crore in Q2. The net margins for the bank have slid to 3.19 percent from 3.31 percent in the corresponding period.

Also read: HDFC Bank Q3FY24 earnings rock stock markets, raising some near-term concerns

Irrational competition for deposits

Rikin Shah, banking analyst at IIFL Securities, has outlined the key earnings drivers for banks in a four-part report.  

Each bank has adopted different approaches to gain customer share and deposit share, in their ‘race for deposits’. As the system liquidity has been tightening, HDFC Bank has been aggressive in distribution expansion, while other private banks have also embarked on branch expansion. Historically, there is a high correlation between deposit market share gains and branches.  

In the last one year, HDFC Bank has opened around 1,500 new branches—3x of the branch additions by ICICI Bank and 6-7x of other larger private banks and State Bank of India (SBI). More importantly, 62 percent of HDFC Bank’s new branches have been opened in semi-urban and rural regions, the IIFL report shows.

KMB has a high branch concentration in the urban and metro region. In fact, the data from IIFL Research and the RBI indicates that KMB has no branches in 88 percent of pin codes where SBI has a presence. The analysis also indicates that 50 to 80 percent of KMB, Bank of Baroda, SBI and Federal’s branches are ‘matured’, which are defined as over 10 years old. While the matured branches can deliver deposit growth in line with nominal GDP growth, developing branches should deliver higher deposit growth, Shah says.

He also says the competition for deposits has “become irrational” with savings account deposit interest rate offered by select mid-size private banks now higher than the peak term-deposit rates offered by larger banks.



Shah now estimates funding costs to increase further by 5 to 50 basis points for the banks under its coverage; higher for ICICI Bank and KMB. “Basis our analysis of the potential residual loan and deposit re-pricing, we expect spreads to decline further by 5 to 40 basis points. ICICI Bank and Kotak Mahindra Bank should see higher NIM compression; and lower for Axis Bank and SBI,” he said in a note to clients on January 11.

Banking analysts had raised the re-pricing of deposits and the trend in the cost of funds, even at their October 2023 analysts call.  

KMB’s consumer banking president Shanti Ekambaram allayed fears by saying, “If you look at the average tenor of our liabilities which we've been talking about, it's roughly about 10 months to 11 months. And if you look at the interest rate cycle, we more or less are close to closing the 10 months to 11 months. So my sense, except for global factors, tight liquidity, increase in rates otherwise, we're more or less there on the re-pricing, maybe a quarter or so. The cycle of re-pricing has come its distance,” she told analysts.  

Nomura’s banking analyst Param Subramanian, in a January 9 note to clients, says he expects “deposit costs for large private banks to peak out by Q3FY24F.” In Q3, we expect NIMs for ICICI Bank, Axis Bank and Kotak Mahindra Bank to moderate further by 10 to 15 basis points quarter on quarter as deposit costs outpace incremental expansion in lending yields.

Also read: Fincare merges with AU Small Finance Bank to create pan-India SFB with diversified portfolio

Pace of credit growth challenging

With liquidity still tight and the RBI raising the risk weightage on unsecured loans, banks are going to find picking up their pace of credit growth more challenging in coming quarters. A Jefferies India report in December 2023 had said that “the wedge between banks’ credit and deposit growth has halved from more than 700 bps last year to 300 bps now. Still, the gap is negative and securing funds for growth will remain a key challenge for lenders,” it noted.

Another challenge for banks is how to keep improving the optics for a better investment rating amongst equity analysts, assuming that profitability stays high and margins keep expanding but trying to ensure that the cost-to-income remains low.  

Nomura’s Subramanian said key to watch out in Q3 is “any sequential pick-up in credit costs (or a moderation in growth), especially led by unsecured retail loans. Of note, we factor in a pick-up in credit costs for AU SFB (to around 100 basis points from 80 bps in Q2) as its contingent provision buffers have largely been used up.”

The recent regulatory tightening from the RBI, through the increase in risk weightage on unsecured lending, and the RBI’s keenness to lower the credit-to-deposit (CD) ratio means that banks could face a slowdown in the loan growth run-rate. “We expect banking system loan growth to slow down to 13-14 percent in FY25E,” IIFL’s Shah says.

The RBI Governor Shaktikanta Das, speaking to journalists on the sidelines of the 54th World Economic Forum at Davos this year said, “There should not be exuberance in lending and there should be some correlation between deposit base and credit growth.”  

Sectoral bank credit data from the RBI released in December-end showed that the pace of growth of credit to India’s industry has halved to 6.1 percent for the 12 months to November 2023, compared to 13 percent for the corresponding period for November 2022.

“Despite the recent moderation in credit growth, we expect it to remain strong at 15 percent for FY24. The credit growth may further moderate in FY25 to 12-13 percent amid a tight liquidity environment,” says Anil Gupta, VP, financial sector ratings at ICRA. “This coupled with higher deposit costs shall moderate the interest margins as well as net interest income growth for banks. However, despite these challenges, a benign credit provisioning requirement shall continue to result in healthy return on equity for the banking sector,” Gupta adds.

In 2023, incremental bank credit was estimated to be around Rs 18 lakh crore and this will only be higher in the current year. Most banks have little option but to keep trying to lend aggressively–within RBI’s checks–if high margins are to be maintained. There could be some compression in earnings growth for FY25 but there is no broad credit supply problem or a concern surrounding economic growth.