Q3FY2008 Banking Earnings Preview

• Last year, the cash reserve ratio (CRR) increased by 50 basis points to 7.5% effective from November 10, 2007, which should erode three to four basis points sequentially from banks' net interest margins (NIMs) during the third quarter of FY2008.
• Banks have discontinued their special deposit schemes and also cut deposit rates marginally. This together with some re-pricing of the bulk deposits at lower rates will restrict the escalation in the deposit costs sequentially. 
• The sequential increase in the incremental credit deposit has been sharp. With the lending rates mostly remaining firm, the yields on advances should provide some fillip to the NIMs on a sequential basis.
• The non-interest income growth is likely to remain strong and be driven by a higher treasury income, as both bond and equity markets performed well during the quarter. 
• The 10-year benchmark government bond yields have declined sequentially by 13 basis points. However, the yields at the shorter end for two-year and three-year bonds have declined by four and eight basis points respectively. Hence, some write-back in the mark-to-market provisions for the large public sector banks like Punjab National Bank (PNB), State Bank of India (SBI) and Canara Bank is expected. 
• Our top picks in the private sector remain Axis Bank and ICICI Bank, while in the PSU space we like State Bank of India, Bank of India and Bank of Baroda. In the non-banking space our pick is HDFC.