Banking party may last only for some more time

Strong systemic credit growth and better earnings performance, aided by a steady improvement in asset quality, buoyed investors’ sentiment towards the sector. As the alongside chart shows, in H1FY23, stressed assets (non-performing assets and restructured assets) slid to the lowest level since FY18. “The biggest theme that has played out for the banking sector this year is stellar credit growth, amid rising cost pressures. It started initially with the retail segment, flowing into the SME and corporate ecosystem,” said Santanu Chakrabarti, India analyst, banking, financial services and insurance (BFSI), BNP Paribas.

Despite tighter monetary policy and liquidity conditions, bank credit grew by 17.5% year-on-year as on 2 December, showed the Reserve Bank of India (RBI) data.

Robust credit growth was accompanied by strong expansion in net interest margin (NIM) in recent quarters. RBI’s interest rate hiking spree led to floating loans getting re-priced at a faster rate than deposits, giving margins a boost.

The good news is that this party may last for some more time before deposit rates are raised. “While all banks should see better performance in the remainder of FY23, the quantum of margin expansion will reduce as deposits catch up, and NIM may peak out in Q4 FY23,” said Gaurav Jani, research analyst, Prabhudas Lilladher Pvt. Ltd.

In FY24, the sector’s margins are expected to moderate.

It is worth noting that systemic deposit growth has been significantly lagging credit growth over the past few months. With expectations that credit growth will continue to remain strong, banks will have to raise deposits to fund the loans. So, the pace of deposit mobilization is a key monitorable. Further, the scramble for deposits would push the sector’s competitive intensity higher.

As credit-to-deposit (C-D) ratios continue to expand, it may pose a structural risk on loan growth, primarily for large private banks considering their high C-D ratios, Nomura Financial Advisory and Securities (India) Pvt. Ltd said in a report dated 19 December. The C-D ratio indicates how much of deposits mobilized by a bank has been given as loans.

“However, public sector banks are relatively immune given their lower C-D ratios (~72% for state -owned enterprise banks (coverage) and 88% for private banks (coverage)),” added the report.

Relative to Nifty50, both Nifty PSU Bank index and Nifty Private Bank Index have given mouth-watering returns in 2022. However, between the two, public sector lenders have staged an impressive comeback. In 2022, the Nifty PSU Bank index has surged by 67%, racing past the Nifty Private Bank index, which rallied 21%. A turnaround in public sector lenders’ performance can be attributed to their improving balance sheet strength. According to Jani of Prabhudas Lilladher, post Q2FY23 earnings, public sector banks saw higher earnings upgrades than peers in the private sector.

Meanwhile, the Nifty Bank index is trading at FY24 price-to-book multiple of 2.09x, showed Bloomberg data. Analysts said the valuation is still lower than pre-covid levels, which could leave room for some upside. That said, investors should not get complacent. The sustenance of this rally depends on how factors such as movement in cost of funds and deposit trends, pan out. Unless RBI changes its tightening stance, softer deposits will be a challenge for the sector, warned analysts.