A new found focus on low-cost deposits is the most striking aspect of commercial banks July-September quarter earnings.

In this quarter, Axis Bank Ltds demand deposits rose 49% to Rs29,085 crore from Rs19,579 crore in the year-ago period. For HDFC Bank Ltd, demand deposits now account for 52.5% of its total deposit base, possibly the highest in the industry. ICICI Bank Ltd, the biggest Indian bank in terms of market capitalization, has increased its demanddeposit by 38% year-on-year in this quarterfrom Rs41,997 crore to Rs57,827 crore. Demand deposits or savings and current accounts are key to banks profitability, particularly at a time they cannot raise their lending rates due to intense competition. So, the best way to keep the net interest margin (NIM) intact is to bring down the cost of deposits. This is possible by rapidly expanding the portfolio of savings and current accounts. Term deposits that have a tenure between one week and a few years are an expensive liability for a bank as the interest paid on such deposits can be as high as 11%. As a matter of fact, some of the banks paid 13% interest on bulk term deposits last year. In contrast, no interest is paid on current accounts. These accounts, normally kept by high networth individuals and entrepreneurs, besides corporations, allow a consumer to make many transactions daily. Banks insist on a minimum balance for such deposits. Ditto about savings accounts where banks pay 3.5% interest. In reality, the actual cost of savings accounts is less than this as banks pay interest on the minimum balance kept between 10th and the last day of a month. The average cost of savings accounts is less than 3% and overall the cost of demand deposits could be even less than 2%, depending on the combination of current and savings accounts (CASA) of a particular bank. Despite their countrywide branch network, not too many public sector banks have a substantial CASA in their portfolio as semi-urban and rural branches are not a huge source of low-cost deposits. The urban middle class is the largest contributor to the low-cost deposits and here the new generation private banks, that came into existence in mid-1990s, steal a march over their public sector counterparts. They have put in place arrangements with

corporations for the salary accounts of their employees. Technically, these salary accounts are zero-balance accounts, but at any given point of time, a professional keeps at least 30% of her monthly income in her savings accounts, looking for investment opportunities. Among the big public sector banks, Punjab National Bank (PNB) has the highest CASA46.16% of its total deposit portfolio in March 2007. It is followed by State Bank of India (43.57%) and Central Bank of India (42.09%). Only two other state-run banks have more than 40% CASA. They are Bank of Maharashtra (43.16%) and United Bank of India (42%). Barring a few, most of the public sector banks have been actually seeing their low-cost deposit portfolio come down over the years. For instance, Bank of Barodas CASA has come down from 36.45% in March 2005 to 33.18% in March 2007. In the case of Syndicate Bank, the downward movement is much sharperfrom 38.84% to 32.23 % in the last two years. Indian Overseas Bank, too, has seen an erosion in its CASAfrom 38.88% in 2005 to 34.86% in 2007. Despite this, most public sector banks NIM has been on the rise. NIM and spread are the two key financial parameters that give an indication of a banks operational efficiency. NIM is arrived at by dividing a banks net interest income by its average interest-earning assets while spread is the margin between the yield on assets and cost of liabilities. PNBs NIM has risen from 3.87% in 2005 to 4.07% in 2007. Bank of Indias NIM during this period has gone up from 2.91% to 3.20%, and that of Bank of Maharashtra, from 2.76% to 3.07%. So, though some of the banks have shown erosion in their NIM, the downward movement is not very sharp and except for Syndicate Bank, Oriental Bank of Commerce and UCO, no public sector bank has less than 3% NIM in March 2007. In the private sector, HDFC Banks NIM is 4.32%, the highest among Indian banks. ICICI Banks NIM is 2.57% and that of Axis Bank is 2.92%. Globally, Indian public sector banks are unique as no financial intermediary in any other country enjoys as much cushion in terms of NIM as they do. This is

because when the interest rates declined between 2000 and 2004, the public sector banks passed on the benefit to customers by slashing their lending rates but the cut in deposit rates was even sharper. Indeed, the average NIM of Indian banks is double that of global banks but their return on assets (RoA)the single most important profitability indicator is comparable with their global peers. Except for PNB, none of the large Indian public sector banks has more than 1% RoA. Even PNBs RoA actually dropped from 1.09% in 2006 to 1.03% this year despite an increase in its NIM. This is because the bulk of the NIM goes in taking care of operating expenses and credit cost, including provision for bad assets and write-offs. The operating expenses of public sector banks is above 2% of their assets and the wage bill accounts for almost three-fourth of the operating expenses. One of the main reasons behind global investors love for Indian bank stocks is their high NIM but this alone cannot keep them profitable for long. They need to pare their operational expenses and the huge wage bill.