Banks had a blockbuster quarter. But don’t let that fool you

One of the most conspicuous factors underpinning banks’ performance in the last quarter of 2023-24 was steady loan growth, in the range of 15-25%. The growth was primarily led by the high-yielding retail segment, with the corporate vertical staying flat or even posting a decline in some cases.

HDFC Bank, the country’s largest private sector lender, saw a 3.5% sequential uptick in retail loans, even as the corporate and wholesale book shrunk 2.2%. Both numbers were higher than the corresponding period in 2022-23, but year-on-year figures are not comparable as the bank concluded its mega merger with HDFC on 1 July 2023. The retail vertical comprises 50.6% of its loan book, followed by commercial and rural banking (CRB) at 32.3% and corporate and wholesale at 17.1%.

ICICI Bank, too, saw retail loans growing at a healthy clip of 19.4% on-year, driven by mortgages (up 14.9%), personal loans (up 32.5%) and credit cards (up 35.6%). Retail accounts for 54.9% of its total loans, while for Axis Bank, it is even higher at 60%. Despite the higher base, Axis Bank saw its retail advances grow 19.6% year-on-year, compared to small and medium enterprises (SME) at 17.7% and corporate at just 3.3%.

“Within retail, management continues to focus on high-yield segments like rural loans (+15% quarter-on-quarter or q-o-q), personal loans (+10% q-o-q), small business banking (+6.9% q-o-q) and credit cards (3.4% q-o-q). It clearly stated its intention to grow segments with high risk-adjusted return on capital," analysts at BNP Paribas stated in a note.

Another heartening trend was the continuing improvement in asset quality. Both non-performing loans and slippages were at stable levels for lenders.

“Credit growth continues to be strong for most of the banks; there has been a pickup in yields in various products, which has helped protect net interest margins (NIMs). Asset quality continues to be benign across product portfolios and some of the banks are using the current environment to make contingency or floating provisions, which is a step in the right direction," Christy Mathai, fund manager—equity at Quantum Asset Management Company, told Mint.

Rock and hard place

The robust, post-pandemic economic recovery has seen a surge in credit growth, especially in the retail segment. However, this has also led to banks’ loan-to-deposit ratio (LTD) ratcheting up as deposit growth has failed to keep pace.

The credit-to-deposit (CD) ratio or LTD is a key liquidity gauge of a bank which shows how much of its deposits have been given out as loans. For example, a CD ratio of 80% means a bank has lent out ₹80 of every ₹100 raised as deposits.

A high CD ratio, therefore, poses liquidity and credit risks for a bank. If a high portion of a bank’s deposits is lent out as loans, then any unforeseen spike in withdrawals can pose an existential threat for the lender.

The CD ratio of banks is at a decadal high of 80%, CareEdge Ratings stated in a March 2024 report.

While there is no regulatory threshold which has been prescribed for the CD ratio, a range of 70-80% is generally seen as healthy. In December last year, the Reserve Bank of India (RBI), India’s central bank, had reportedly asked some lenders with high CD ratios to bring the number under control.

This is where lenders face Sophie's choice.

There are only two ways to bring down a ratio— either decrease the numerator or increase the denominator. Decreasing the numerator (that is credit) means sacrificing growth, which any company is loath to do. The other option, increasing the denominator (deposits), would dent margins as banks would need to pay higher interest to attract depositors. Hard as it is, the second one is the only viable option. But like most things in life, it is easier said than done.

Credit growth has outstripped deposit growth for the past few financial years. In 2023-24, against a deposit growth of 13.5%, credit growth stood at around 20%. The credit growth figure has also received a boost following the mega merger of HDFC and HDFC Bank, but even adjusting for that, the number stands at about 16%.

According to RBI data, bank credit growth exceeded the deposits increase by ₹2 trillion in 2023-24. A key contributor to this trend has been the rise of equities as an asset class.

Retail investors have made a beeline to Dalal Street amid this multi-year bull run.

From 40 million at the end of 2019-20, the number of demat accounts has vaulted to 151 million as of March 2024. Monthly inflows into mutual funds through systematic investment plans (SIPs) have also marched higher, crossing the ₹20,000 crore-level for the first time in April. Assets under management (AUM) of the domestic mutual fund industry breached the historic mark of ₹50 trillion in December 2023, nearly doubling from ₹25.5 trillion in the quarter ended June 2020.

Mutual fund AUMs stand at ₹57.3 trillion at present. Though this is still around a fourth of total bank deposits (more than ₹200 trillion), the incremental fund flows are skewed more towards equities (and other asset classes like gold and real estate) rather than the ‘old-fashioned’ and tax-inefficient bank fixed deposits.

While the top lenders posted encouraging deposit growth in Q4 (HDFC Bank at 7.5% q-o-q; Axis Bank at 6.3%; ICIC Bank at 6%), the share of current account and savings account (CASA) deposits—the cheapest source of funds for banks—lagged on an annual basis.

Bank managements are acutely aware of the challenge at hand.

“The key focus over the medium to long term (medium is between two and three years) is to focus on improving our profitability metrics defined as the ROAs (return on assets) and the earnings per share. To achieve that, the key is to ensure the sustainability of our deposits franchise, especially the retail deposits franchise," Sashidhar Jagdishan, HDFC Bank’s managing director and chief executive officer, said during its post-earnings call.

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Jagdishan acknowledged that there is a “competitive environment" in the retail deposit market but added that the company will not overpay for funds but rather bank on its “enhanced customer engagements and elevated service-first culture".

But will depositors be satisfied with “enhanced customer engagements" at the cost of higher returns?

Most new investors anyway prefer equities over debt, while even for bank fixed deposit holders, the aggregate movement is towards seeking higher yields.

As per the latest quarterly data from RBI, rising return on term deposits has been driving the compositional shift in bank deposits. The share of term deposits in total deposits increased to 60.3% in December 2023 from 57.2% in March 2023.

On an incremental basis, term deposits accounted for nearly 98% of the total deposits with scheduled commercial banks during April-December 2023, while the share of CASA deposits went down.

Not just that, deposits moved to higher interest rate buckets—the share of term deposits bearing over 7% interest rate rose to 61.4% of the total term deposits in December 2023 from 54.7% a quarter ago and 33.7% in the year-ago period.

Against this backdrop, most analysts expect banks’ funding cost to inch higher as they compete for deposits, which will consequently weigh on their net interest margins (NIMs) or the difference between the interest income earned and the interest paid by a bank.

The spike in cost of funds (CoF) was clear in the Q4 earnings. HDFC Bank’s CoF rose to 5.66% from 4.32% in the year-ago quarter, while that of ICICI Bank was at 5% (from 4.2%) and Axis Bank at 5.2% (from 4.5%).

Revising its outlook on the domestic banking sector from positive to negative last month, ratings agency Icra said banks’ pace of growth is expected to moderate in 2024-25 amid challenges in deposit mobilization and regulatory tightening. With the share of CASA in total deposits continuing to decline, it said pricey deposits will crimp banks’ NIMs this financial year.

SBI, which had a blockbuster quarter, saw its net interest income rise by just 3% year-on-year, showing the burden of higher cost of deposits.

However, some experts also maintain that the hit on margins will not be as high as many fear.

“There are two factors. One, liquidity was tight in the system on account of the government not spending enough, and that should reverse post the elections," Kaitav Shah, lead BFSI analyst at Anand Rathi Institutional Equities, told Mint. “Secondly, in Q4, both CASA and term deposits have shown strong growth, although that might not be replicable in Q1 FY25 for most of the banks. The credit-deposit ratio could again inch up a bit, which will protect the NIMs, but we don’t expect a sharp hike in deposit rates," he added.

Tech talk

When software is eating the world, can banking be far behind?

One notable trend in this earnings season was the increased focus on banks’ technology arsenal. Managements also spent a fair bit of time detailing their IT spends and digital offerings during the post-earnings calls. So much so, some analysts even singled out digital capabilities as one of the key differentiators for assessing banks.

Vocalizing an issue popular with a section of netizens, BNP Paribas noted how customers’ disappointment with HDFC Bank’s app is a matter of concern. “The app is, in many ways, the face of its technology strategy and effectively its branch presence in the new digital world. Two delays on app revision timelines does not bode well, in our view," it stated.

“Structural concerns with legacy data architecture are something HDFC Bank shares with other older banks. Given their performance on the front end (app), efforts to fix the deeper, more structural problem come under a cloud for sure, in our opinion. This will become incrementally relevant to our thesis as the first leg of valuation re-rating from currently distressed levels is completed," it added.

In contrast, it applauded ICICI Bank’s tech architecture.

“The bank’s tech and digital investment efforts appear to have set the benchmark among large private-bank peers. While the iMobile app’s popularity provides us some evidence of the bank’s tech and digital focus, its efforts span segments and functions," it said in another report.

Analysts at domestic brokerage firm Geojit highlighted how ICICI Bank’s digital transformation allows it to expand its distribution. “Strong growth momentum in advances and deposits is expected to continue, as the bank with its technological advancement and better reach is well-equipped to capitalize on growing demand," they said.

Road ahead

The ‘war for deposits’ is not only posing a threat to banks’ margins but to credit growth itself.

S&P Global Ratings expects the sector’s credit growth to moderate to 14% this year from 16% in 2023-24 if deposit growth remains tepid. “We expect banks to bring down their loan growth in FY25 and bring it in line with deposit growth. If banks do not do that, they would be paying higher to get wholesale funding, which will impact profitability," Nikita Anand, S&P Global Ratings director, South and South-east Asia, said during a webinar on 24 April.

That said, analysts maintain that since the underlying fundamentals of the economy remain strong, the current predicament of banks is a temporary and not a structural issue.

“Over a longer period, at a system level, credit growth drives deposit creation in the economy. So, we do not expect the current scenario to persist over the longer term," Quantum’s Mathai said.