Indian banks are turning to low-cost deposits, refinancing debt and raising cheap foreign capital to protect margins squeezed by higher interest rates at home, bank officials and analysts said.

India's central bank last month raised interest rates for the seventh time in less than a year and more rate hikes are on the card to curb stubbornly high inflation.

State-run lenders Indian Overseas Bank, IDBI Bank and Rural Electrification Corp (REC) are raising cheaper funds abroad, but most are turning to the low-cost current account savings account (CASA) deposits.

Foreign rates are at historical low levels, while domestic rates are high, HD Khunteta, director of finance at REC, said, explaining the rationale.

Loan growth for most banks have been strong so far in FY11 ending March, leading to higher proportion of wholesale funding, partly from refinancing institutions.

Rather than focusing on balance sheet growth, we focus on churn and fee income, said Jaideep Iyer, president, financial management at Yes Bank

We focus on non-interest income such as trade, forex, advisory services with the same clients. We are chasing more customers so that gives more granularity to our balance sheet.

Others like IDBI Bank are exploring options to refinance loans and deposits, shed high-cost bulk deposits and look to overseas borrowing.

IDBI plans to raise $1 billion by September as also Indian Overseas Bank, which plans to raise a similar amount, half before end-March.

If refinancing gives us a lower cost, or foreign currency borrowing gives us a lower cost, we will access those sources rather than deposit sources, said Melwyn Rego, executive director, IDBI Bank.

LOW-COST DEPOSITS

The focus on low-cost current account savings account (CASA) deposits has also been rewarding for lenders.

Cost of deposits is going up but we have been able to bring that down... we have been able to substitute high cost deposits with lower costs CASA and with refinancing, said S. Shridhar, chairman and managing director, Central Bank of India.

CASA share of its deposits increased to 34.9 percent in Oct-Dec from 29.9 percent a year-ago, while its cost of deposits dropped to 5.7 percent from 6.1 percent.

Most mid-sized banks are targeting CASA of 34-35 percent over the next two years, in line with industry average.

Margins will be under pressure for mid-cap banks but what we have to look for is how much will margins come down, specially for those which have lower CASA ratios, said Vaibhav Agarwal, sector analyst at Angel Broking.

Agarwal recommends United Bank of India, J&K Bank, Dena Bank and Indian Overseas Bank amongst the mid-cap banks because of their dirt cheap valuations and reasonably good CASA ratio.