Markets
Margins key to banks, but don’t ignore operating expenses
Summary
Credit growth was healthy in Q1, but deposit growth was relatively modest. With deposit re-pricing catching up, the NIM reversal trend would continue to play out for banks.
Credit growth was healthy in Q1, but deposit growth was relatively modest. With deposit re-pricing catching up, the NIM reversal trend would continue to play out for banks. Now, the pace of deposit mobilization is crucial, but with intensifying competition, investors need to shift their focus on the sector’s operating expenses (opex) trends.
“Taking advantage of the benign credit costs environment, some banks are aggressively reinvesting in the business, in terms of branch expansion, portfolio expansion and investments in digital platforms. Hence, operating expenses are expected to remain elevated in FY24 for banks continuing with the investment phase," said Dnyanada Vaidya, analyst-BFSI, Axis Securities.
The unfavourable combination of declining NIMs coupled with rising opex hurt the sector’s sequential net interest income and net profit growth in Q1. For private banks, non-staff opex grew 26% y-o-y on rising distribution, business volumes and continued IT spend, said analysts at ICICI Securities. PSU banks saw a limited rise in non-staff opex, but staff cost was up by over 30% y-o-y, partly driven by wage bipartite provisions, starting Q3FY23, said the analysts in a report.
On NIMs, further decline is inevitable. “For most banks, Q2FY24 will see margin compression as deposits continue to reprice. Also, there is limited room for yield improvement on advances," said Kaitav Shah, BFSI analyst, Anand Rathi Institutional Equities. However, there is some respite. Despite NIM compression in H1FY24, for FY24, NIMs are expected to remain flat, or perhaps see marginal compression compared to last year, for most banks, he added.
With the Reserve Bank of India pausing rate hikes, the impact on the sector’s cost of funds and yields on advances will be important. Asset quality has been stable for most banks, despite Q1 being seasonally a weak quarter. For now, analysts do not foresee near-term risks on this parameter for banks. Management commentary of key lenders indicates that systemic loan growth momentum is likely to sustain. But a repeat of strong credit growth seen in FY23 is unlikely.
However, the muted returns of sector index Nifty Bank indicate that potential downside risks are outweighing positives. So far in 2023, the index has rallied just 3.5%. Hereon, re-rating triggers for the banking sector broadly hinges on the quantum of NIM compression and the costs trajectory.
