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5 trends to follow on bank interest rates
The Law of Demand and Supply is the most fundamental economic theory. What it says is simple—higher demand leads to an increase in prices. The beauty of the theory lies in how you can see it in your everyday life around you. Take the stock market, for example. Is a particular stock in demand? Boom, its prices shoot up. This applies to the banking sector too. You can see the law in play in bank interest rates, especially in recent times.
Here are five interesting trends that are a result of the supply-demand dynamics:
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Lending rates on the rise:
Companies usually cheer when they hike prices. It usually means higher profits. Similarly, banks can profit more if they sell loans at a higher interest rate. Recently, loan interest rates or lending rates have been increasing. The largest lender in the country—State Bank of India (SBI)—announced a 0.25 percentage point increase in MCLR-based loan rates earlier in March 2018. But it’s not limited to SBI alone. A recent Kotak Institutional Equities report suggests that it could be an industry-wide trend. To monitor this, track ‘incremental credit-deposit ratio’. It shows how much of a bank’s latest deposits are being given out as loans.
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Liquidity crunches to bite:
A higher lending rate is not just a factor of greater demand. It could also be because of less supply. After all, the Law does state that a cut in supply could push up prices—or in this case, interest rates—too. A bank’s supply of money can be seen in its level of liquidity. Higher liquidity means more money is available to lend. However, the Kotak IE report suggests that liquidity in the system has shrunk drastically since September 2017. This could also push up lending rates further.
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Good news for NIM:
When you increase prices, there are chances that it could affect demand. After all, a higher interest rate could deter a few loan borrowers. However, the good news is that loan demand has been improving in the last few months. “Rising interest rates coupled with improving loan growth is an ideal scenario for banks from a NIM point of view,” the Kotak IE report said. NIM or Net Interest Margin is a key indicator of a bank’s profitability. Rising NIM means higher bank profits.
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Bank borrowing turns costlier:
While higher loan rates and strong loan demand are positive signs, there are a few negative factors at play too. What could make the situation murky is the subsequent increase in deposit interest rates. After all, when you increase loan rates, deposit rates tend to rise too. This means higher cost of borrowing for banks (after all, deposits are a cheap way of borrowing). Higher cost usually affects profits.
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Rising bond yields to impact:
Government bond yields have risen 1.25 percentage points in the last six months. Usually, when yields rise, bond prices fall. This could affect banks’ investments in government bonds. When the value of investments falls, banks have to report that as a loss. This could affect bank profitability too.
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23.8%
The banking industry is the backbone of the economy. But there’s another reason too why investors are interested in keeping track of the sector: The increasing prominence of financials in Nifty. Private banks will command 23.8% of the Nifty from the latest reshuffle starting April 2, 2018. It’s up from 16.9% in 2012, as per a Livemint report. But ensure you track Non-Banking Financial Companies (NBFCs) too closely as they have a higher weightage too. This means, whatever affects the bank and NBFC stocks are likely to have an impact on the Nifty.
