India’s largest private lender, HDFC Bank, is feeling the effects of the Reserve Bank of India’s (RBI) move to withdraw liquidity to fight inflation. As part of its strategy to combat excess liquidity in the banking system, the RBI has introduced an incremental cash reserve ratio (CRR), which has raised concerns about deposit confiscation and its impact on bank stocks.

Since the announcement, bank stocks have declined, with the Nifty Bank Index down almost 2% by the close on Aug. 22, compared to a 1.2% decline in the Nifty 50 Index. In particular, HDFC Bank saw a decline of around 4%, the sharpest decline among its peers in the banking index.

Market analysts are warning that HDFC Bank remains a strong long-term investment option despite the near-term uncertainties surrounding the bank’s merger and a potential decline in net interest margins (NIMs). The bank’s track record of revenue growth, quality assets and industry-leading loan and deposit growth are factors that support this perspective. Additionally, growth in high yield unsecured products could offset the impact on NIMs.

“Step by step reassessment”

However, analysts suspect HDFC Bank’s re-rating could be gradual due to increasing competition and the potential challenges posed by a high cash reserve ratio. The bank’s merger with HDFC, effective July 1, has raised concerns that RBI’s liquidity-draining measures could hurt net interest margins more than expected. Due to the merger, the bank had already expected a margin decline for the September quarter.

RBI’s decision to use an incremental CRR as a tool to manage excess liquidity caught the market by surprise and led to losses in bank stocks. The measure requires banks to hold an additional 10% cash reserve between May 19 and July 28 for the increase in their net demand and time liabilities (NDTL). This temporary measure aims to remove excess liquidity of INR 100,000 from the banking system. Nonetheless, the RBI assures that there will be sufficient liquidity to meet the economy’s borrowing needs.

  • Published August 26, 2023 at 08:00 IST

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