09 June 2022 Sector Update

BFSI
New normal rate cycle; brace for transmission effects
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-
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-
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-

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- Krishnan ASV
through is likely to incrementally diminish through the up-cycle on account venkata.krishnan@hdfcsec.com
of the competitive intensity in these categories. +91-22-6171-7314

 Lagged deposit-side re-pricing: The re-pricing of the deposit side of the

Deepak Shinde
balance sheet is likely to happen gradually, given the surplus liquidity in the
deepak.shinde@hdfcsec.com
system and healthy C/D ratios. Banks have raised their term deposit pricing
+91-22-6171-7323
by ~10-25bps over the past few months, which is likely to gradually reflect in
the incremental cost of funds for the banking system.
Neelam Bhatia
 ICICIBC and SBIN best levered to up-cycle: We identify ICICIBC (48% neelam.bhatia@hdfcsec.com
EBLR; 22% MCLR for the domestic loan book) and SBIN (34% EBLR; 41% +91-22-6171-7341
MCLR) as best positioned to capitalise on this stage of the rate cycle.

HSIE Research is also available on Bloomberg ERH HDF <GO> & Thomson Reuters
BFSI: Sector Update

New interest rate cycle begins; a new normal ahead

 A sharp turn in the rate cycle: Given the stubborn nature of inflation and extent of
over-shooting in this case, we expect a long road to policy normalisation. A rising
rate environment typically entails three stages: a) Stage 1, where asset-side re-
pricing lags deposit-side re-pricing, resulting in softer NIMs; b) Stage 2, where
asset-side re-pricing catches up and occasionally overshoots the liability-side re-
pricing (NIM-accretive); and c) Stage 3, the final phase of rate hikes, where lenders
are reluctant to transmit higher rates to borrowers in order to avoid
disproportionate credit risk.

 Rising inflation drives accelerated rate hikes; tighter liquidity: The increasing
inflation print, far above the RBI’s target range, has led to a sharp turn in the rate
cycle with the RBI effecting an accelerated 90bps repo rate hike during the past few
weeks. We believe that banks are currently in the middle of first and second stage
where the rate hikes are likely to be margin accretive.

Exhibit 1: Steep rise in inflation (CPI) over the last few Exhibit 2: Repo rate – still near hisotric lows
months

Source: Bloomberg, HSIE Research Source: Bloomberg, HSIE Research

 Near-term margin accretive for banks: The sharp rate hikes augur well for the
banks, partly owing to RBI’s efforts to ensure monetary transmission. Banks have
gradually migrated their loan book towards EBLR (externally benchmarked rates).
Leading private banks have ~35-48% of their loan cook currently linked to EBLR,
with a 3-month reset clause, while the industry average of the loans linked to EBLR
for various retail segments is at ~40%.

Exhibit 3: Loan book composition of leading private Exhibit 4: % of loans benchmarked to various interest rate
banks (Mar-22) categories for the banking system (Dec-21)
Mar-22 Fixed Rate EBLR MCLR Others Dec-21 Base rate MCLR EBLR
ICICIBC* 30% 48% 22% Industry (Large) 6% 71% 20%
AXSB 32% 41% 23% 4% Trade 3% 46% 49%
HDFCB 46% 38% 16% MSMEs 4% 24% 69%
IIB 50% 50% Personal Loans 4% 45% 46%
KMB 30% 48% 20% 2% Housing 6% 33% 58%
SBIN 25% 34% 41% Vehicle 1% 60% 31%
Source: Company, HSIE Research | * Domestic advances | Note: Education 23% 49% 23%
HDFC Securities is a subsidiary of HDFC Bank
Other Personal Loans 1% 61% 32%
Source: RBI, HSIE Research

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BFSI: Sector Update

 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 the
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 generally crowded segments, the pass-through is likely to incrementally
diminish through the up-cycle on account of the competitive intensity in these
categories. On the other hand, the large corporate portfolio (20% EBLR linked) and
the vehicle finance loan book are likely to reflate slower.

Exhibit 5: MSME and Housing portfolios likely to witness faster reflation

Source: RBI, Company, HSIE Research | Note: Data for personal segments is as of Sep-21 | MSME data
as of Mar-21 | Industry (large) and trade data taken as average of top-tier banks

 Slower re-pricing of liabilities: The re-pricing of banks’ deposits is likely to be

more gradual given the surplus liquidity in the system and healthy C/D ratios.
Banks have increased their term deposit rates by ~10-25bps during the last couple
of months and the incremental rate hike is also expected to be gradual.

 Lopsided transmission on the back book increasingly getting addressed: The

increasing migration of assets towards EBLR is likely to address the lopsided
monetary transmission challenges of the past. The following exhibit highlights the
monetary transmission on the incrementally disbursed loans as well as on the back
book. While the transmission on the freshly disbursed loans seems fairly healthy,
the same is lacking on the MCLR-linked loans.

Exhibit 6: More efficient monetary transmission on incremental loans; lower transmission on the back book
Repo rate MCLR hike Wtg avg lending rate - fresh loans
(bps) hike PSU Banks Private Banks SCB PSU Banks Private Banks SCB
Apr'16 - Sep'17 (50) (110) (85) (115) (123) (143) (117)
May'18 - Sep'18 50 20 30 27 41 7 26
Jan'19 - Mar'22 (250) (135) (101) (135) (247) (156) (211)
Source: RBI, HSIE Research

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BFSI: Sector Update

Disclosure:
We, Deepak Shinde, PGDM, Krishnan ASV, PGDM & Neelam Bhatia, PGDM authors and the names subscribed to this report, hereby certify that all of the
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