Indian banks' deposit base to increase 1-2%: Moody's

It's driven by the demonetization inflows.

Moody's Investors Service says that the earnings of Indian banks for Q3 FY2017 show that the government's decision to remove a high proportion of notes from circulation (demonetization) has led to a slowdown in economic activity that weighed on demand for credit among companies and retail borrowers during Q3 FY2017.

"Overall, demonetization has significantly impacted credit demand and deposit growth, but the effect on asset quality has been mixed, while retail payment systems -- such as card transactions and mobile wallets -- have benefitted," says Srikanth Vadlamani, a Moody's Vice President and Senior Credit Officer.

Moody's conclusions were contained in its just-released report on its 15 rated banks in India, "Banks -- India: Q3 Earnings Highlight Pressures from Demonetization; NPL trends mixed". The Indian government announced its demonetization program on 8 November 2016.

"Looking ahead, while commentary from the banks points to a rise in activity in January, it is still below the levels seen in October, and we expect the quarter ending 31 March 2017 to show more adverse trends; but the impact on asset quality from demonetization should be manageable for the banking sector," adds Vadlamani.

Here's more from Moody's:

For example, while the banks' retail segment has seen some weakness, its biggest part -- home loans -- has shown a stable performance. More importantly, economic growth seems to be recovering from demonetization, although gradually, which should cushion the impact on the banks' overall asset quality.

While deposit growth has been strong this quarter, driven by the demonetization inflows, it should moderate going forward as cash availability increases and restrictions on cash withdrawals expire, a moderation will occur in deposit growth over the next 12-18 months. Overall, banks' deposit base should see a sustainable increase of 1- 2% on account of demonetization.

Retail payment systems such as a cards and mobile wallets have seen a significant increase in transactions, and should continue to see healthy growth. At the same time, given the low base, cash will remain the dominant source of retail transactions for the foreseeable future.

Outside of the impact of demonetization, asset quality trends were mixed.

Both of Axis Bank Ltd and ICICI Bank Limited's have seen significant additions to their NPLs from outside of their already announced watchlist accounts. While we have been expecting asset quality to deteriorate for both, we had expected the deterioration to come predominantly from their watchlist accounts. A continuation of the increasing non-watchlist NPL trend would put negative pressure on the banks' credit profiles.

Asset quality for private sector banks will likely deteriorate. Increased non-performing loans (NPLs) from outside the watchlists of Axis Bank Ltd (Baa3 positive, baa3) and ICICI Bank Limited's are pressuring their credit profiles.

Meanwhile, asset quality trends for public sector banks have been more benign, and the pace of deterioration has slowed in the past two quarters from the levels seen in FY2016.

However, IDBI Bank Ltd has been a negative exception, with the bank seeing significant additions to its NPLs during Q3 FY2017.

Net interest margins will also come under pressure as banks gradually adopt the marginal cost of funds lending rate to price their loans So far, less than 20% of the banks' variable-rate loans have been repriced to MCLR as opposed to their base rate. Because the MCLR is around 85 basis points (bps) lower than base rate, we expect the downward trend in net interest margins to persist.