HDFC Bank shares, which had been climbing in recent weeks due to the anticipation of an increase in MSCI weightage, fell sharply by over 4% on Friday, closing at Rs 1,665.55 on the BSE.

The significant drop was attributed to the bank’s June quarter update, which revealed a notable decline in the Current Account Savings Account (CASA) ratio. The update disappointed investors, leading to a sell-off.

In its first quarter business update, HDFC Bank reported that deposit growth was relatively soft, registering a 15.3% year-on-year increase on a pro-forma basis but remaining flat sequentially.

Moreover, the CASA deposits saw a decline of 5% quarter-on-quarter, which resulted in a 190 basis points reduction in the CASA ratio, bringing it down to 36%.

This decline in the CASA ratio, a key indicator of a bank’s liquidity, was a primary concern for investors.

Shares of HDFC Bank, which had been buoyed by the potential increase in MSCI weightage, dropped to an intraday low of Rs 1,653.70 on the BSE.

This came as a stark contrast to the recent upward trend seen in the bank's stock price.

Despite the subdued deposit growth, HDFC Bank reported that its loan book and deposits grew by 14.9% year-on-year and 16.5% year-on-year, respectively, when excluding the impact of mergers.

However, these figures did little to alleviate investor concerns.

Nomura, a global financial services group, noted that both loan and deposit growth are typically seasonally weak in the first quarter for HDFC Bank, with 1-3% quarter-on-quarter growth observed in the past three years during this period.

However, the reported numbers for this quarter were slightly lower than the usual seasonal trend.

Analysts at Bernstein, who maintain an overweight rating on HDFC Bank with a target price of Rs 2,100, highlighted that the decline in the CASA ratio might counterbalance the benefits of an improved loan mix. On the other hand, Macquarie suggested that the net interest margins (NIMs) of the bank are likely to remain stable despite the decline in CASA.

For the first time, HDFC Bank’s pre-Q1 update included details about the growth in average balances for both deposits and assets under management (AUM).

The bank reported a healthy 4.6% quarter-on-quarter growth in average deposits, while the average AUM grew by 0.8% quarter-on-quarter.

This growth was primarily attributed to a sharp build-up of deposits towards the end of the previous quarter (Q4), which inflated the base on an average basis.

Nomura also pointed out that there seems to be some moderation in core NIMs on a quarter-on-quarter basis in Q1.

HDFC Bank’s NIM stood at 3.44% in Q4, which is significantly lower than the 4%+ levels seen among other large private sector banks.

Despite the recent downturn, HDFC Bank shares have remained relatively flat over the past year.

The recent rally in the stock was driven by speculation about the possible increase in HDFC Bank's weightage in the MSCI Emerging Markets (EM) index.

Analysts at Nuvama predict that the bank’s weightage in the global index could potentially double to 7.2%-7.5%, which could result in an inflow of $3.2 billion to $4 billion.

In conclusion, while HDFC Bank’s first-quarter update showed some growth in deposits and loans, the decline in the CASA ratio and the soft deposit growth raised concerns among investors, leading to a significant drop in the bank's share price.

The potential increase in MSCI weightage may provide a boost in the future, but the current figures have led to cautious optimism among market participants.