Banking stocks have been on fire over the past three months, driving the gains of the broader market, and have been second only to fast-moving consumer goods stocks in terms of gains.
For perspective, the Nifty Bank has surged by 25 percent while the broader Nifty 50 gained 14 percent in this period. Other sectoral indices have underperformed, with gains not more than 20 percent and some such as information technology showing a drop of 1 percent.
Foreign portfolio investors have been loading up on banking and financial shares in August and the trend seems to have continued, so far, this month as well.
The banking index that gained 11 percent in August on the back of foreign investors’ buying has further risen by 5 percent so far in September. What’s more, mutual funds too have been loading up on banking shares.
What lies behind
It is easy to see the drivers of this optimism. India’s banks have cleaned up their balance sheets and are benefiting from bad asset resolutions.
At the same time, the economic recovery has resulted in a swift rebound in credit disbursal. New loans have surged 15 percent from single-digit growth in FY22. Analysts have increased their earnings per share estimates for select banks as well.
“We can see that the outlook on the banking sector is positive. Banks have clean balance sheets and mainly it is the credit growth that is making investors bullish. It is not just loan growth but general consumption demand that is coming back and banks will benefit from this,” said Anand Dama, banking analyst at Emkay Global Financial Services Ltd.
Indeed, the key driver of investor interest, domestic and foreign, is the surge in bank credit and the overall optimism among bankers on demand for credit in the coming quarters.
Analysts at Macquarie Capital note that the nine-year-high credit growth is encouraging as it is broad-based this time, unlike previous cycles. Moreover, bankers believe that they are on the cusp of demand coming for capex.
“A reasonable part of the increase in credit growth is inflation-linked. They are also seeing capex selectively in sectors like renewables, cement, steel, etc. Capex demand has generally been weak over the past several years, but we are likely to see some early signs of capex-related credit growth in 2HFY23, as per the bankers,” analysts at Macquarie wrote in a note.
The performance of banks, especially public sector lenders, in the first quarter of FY23 has given credence to this optimism. Bad loan ratios have plummeted and barring the hit from treasury due to a rise in bond yields, lenders have shown robust growth in both core interest income and non-interest income. The outlook for profitability continues to be positive.
Watch the deposits
That said, investors need to keep this one risk in mind while pursuing bank stocks. Lenders have been able to grow their loan books but deposits have not kept pace. In fact, deposit growth is still in the single-digit territory and the gap between deposit growth and loan growth has widened.
As of August, deposit growth was 9.5 percent against a loan growth of 15 percent. In essence, banks will soon have to resort to large deposit rate hikes which could put pressure on income through margins.
Deposit rate hikes by private sector banks could be steeper compared with public sector lenders though the latter have been ceding market share in deposits to the former. Macquarie analysts expect banks to scramble for funds during the festival season in order to meet credit demand.
“We expect loan growth to exceed deposits growth for most of FY23 on economic momentum. This will lead to an increase in LDR (loan-to-deposit ratio) for banks, which should act as one of the levers for NIM (net interest margin) expansion” analysts at Axis Securities Ltd wrote in a note.
However, Dama of Emkay believes that managing the liabilities side would not be a huge challenge for banks. The focus of investors now is the growth phase of banks, he added.Banking stocks may continue to be in favour but picking the winning bet will mean investors will need to closely monitor the trend in deposits. The ability to raise lower-cost deposits and protect margins will be the factor that helps investors differentiate between banks. Here, the top three lenders seem to be clear winners.