Equity Analysis /

FM & EM Banks: Falling interest rates – friend or foe?

    Rahul Shah
    Rahul Shah

    Head of Corporate & Thematic Research

    Rohit Kumar
    Rohit Kumar

    Global Financials/Thematics

    Tellimer Research
    28 August 2019
    Published byTellimer Research

    Recent central bank rate cuts in Egypt and Sri Lanka follow similar moves in the US, India, Philippines, Mexico, Thailand and Peru. In this report we analyse the likely impact on bank margins in the 21 markets we cover and overlay this with our bottom-up views to find where the opportunities and risks lie. We remain positive on Nigeria and Ghana banks, and cautious on GCC names. For Egypt banks, falling margins could temper their positive volume growth story.

    We see a median 50bps rate cut over the next 12 months for our 21 coverage markets, ranging from flat in Bangladesh and Rwanda to 200bps in Tanzania and 100bps in Ghana. The rate hiking cycle in Pakistan has likely ended, but margins should still rise.

    Long-term pressure on margins for most of our coverage. We estimate a 100bps cut in interest rates structurally lowers margins by a median 10bps and earnings by a median 5ppts. There is a wide dispersion in results, ranging from -10% (India) and -7% (China) to -2% (Uganda, Rwanda, Ghana).

    But banks will reposition to mitigate the margin squeeze. Lower interest rates should facilitate stronger loan growth, and support asset quality. In addition, banks can realise mix shifts (eg, gravitating towards higher-yielding retail/SME lending, and/or focusing on lower-cost funding, such as current accounts). Headline sensitivities therefore likely overstate the negative impact of lower interest rates on revenues and earnings.

    Impact of rate cuts on banks

    Source: Tellimer Research

    Near-term interest rate sensitivities are more balanced. Because bank management will take action to adjust to a lower rate environment, we think near-term (12-month) mismatches are more relevant for equity investors. On this basis, the median impact of rate cuts is broadly flat; Egypt and GCC banks will experience lower margins, and Tanzania banks could see margin expansion. Pakistan banks will profit from recent rate hikes.

    Country highlights:

    • India banks are the most sensitive to margin compression. The 110bps rate cut ytd and additional 40bps rate cut forecast over the next year could knock 9% off 2020f earnings.
    • GCC banks will likely experience more margin compression and profit drag than most other markets, due to their large stocks of free deposits.
    • Nigeria banks will likely prove relatively resilient to an expected 50bps rate cut, given scope to cut funding costs.
    • Pakistan bank 2020f margins will still benefit from the 325bps rate hike ytd.

    Opportunities highlighted by comparing our top-down and bottom-up models: Our analysis supports our positive views on Nigeria and Ghana banks, and also points to potential positive surprises in Sri Lanka and Kenya. In contrast, our findings support our cautious view on GCC banks, but also sound a note of caution to our positive view on Egypt banks.

    Top picks in a rate cut environment. From our eight sector top-picks we highlight HBL PA, CRDB TZ, GCB GN, KCB KN and ZENITHBA NL as names that could benefit in the near term from rate cuts and/or where our top-down analysis points to upside risk to our bottom-up forecasts. Other Buy-rated names worth highlighting include HNB SL, SAMP SL, CAL GN, EGH GN and UBA NL.