India's worthless cash turning into gold for state-run banks

[MUMBAI] Shares of India's biggest state-run lenders are on a roll, thanks to a government ban on high-value notes that took almost four-fifths of the nation's currency out of circulation.

Since the so-called demonetization policy was introduced on Nov 8, State Bank of India and Bank of Baroda have risen at least 4 per cent amid speculation they will benefit more than private-sector peers from the influx of deposits that followed the cash ban, according to IDBI Capital Market Services Ltd. Private-sector rivals HDFC Bank Ltd and ICICI Bank Ltd dropped 7 per cent and 9 per cent, respectively.

The government's surprise move last month to invalidate old 500- and 1,000-rupee notes has driven millions of Indians to banks to deposit the currency or exchange them for new denominations. Lenders had taken in 12.4 trillion rupees (S$262.8 billion) of deposits as of Dec 10, out of the 15.6 trillion rupees of notes canceled, central bank figures show.

"State-run banks are getting to generate a large float of low-cost current and saving account (CASA)deposits after demonetization," AK Prabhakar, head of research at IDBI Capital in Mumbai, said by phone.

Having a large base of so-called CASA deposits, which typically carry lower interest rates, gives banks a cheaper pool of funds from which to lend, bolstering their interest margins. About 43 percent of State Bank of India's deposits were in CASA accounts as of Sept 30, more than HDFC Bank's 40 per cent and ICICI Bank's average of 41.5 per cent for the September quarter, filings show.

While stock traders are betting on the benefits state banks will derive from the cash ban, the same can't be said of the analysts who follow the lenders. Consensus earnings-per-share estimates for this year and next for the members of the Nifty PSU Bank Index - which tracks government lenders - have barely moved since the cash ban was enacted.

One positive sign for earnings: Lenders like State Bank and Bank of Baroda are purchasing more bonds as deposits increase and may end up booking profits from a rally in Indian bond prices, said Sanjiv Bhasin, an executive vice president at brokerage India Infoline Ltd.

Benchmark 10-year sovereign bonds last month capped their best performance since April 2009, though the rally has lost some steam after the central bank unexpectedly held the key policy rate at a six-year low of 6.25 per cent last week. The yield on the 10-year benchmark note was at 6.46 per cent as of 9.20 am in Mumbai on Thursday, still 34 basis points down from Nov 8 levels.

"The cash demonetization will provide the state-run banks a large base of low-cost deposits and huge treasury gains," Mr Bhasin said. "That will remove all negativity in the short term."

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