Banks’ asset quality report reaffirms investor confidence, experts see valuation comfort

So far this year, the Bank Nifty index has gained 12 percent as against 19 percent rise in the benchmark Nifty index

The Reserve Bank of India's (RBI's) report on banks' asset quality and balance sheet improvement has bolstered investors' confidence, setting the financial sector for a potential further rally. Banking stocks, including HDFC Bank, ICICI Bank, SBI, Axis Bank, Kotak Mahindra Bank, and Bank of Baroda, have experienced gains ranging from 7-20 percent in the last month. This surge is attributed to robust credit offtake, balance sheet clean-up, and attractive valuations.

While the banking sector strength is already priced in and the RBI report card was ‘nothing new’ for the markets, banking stocks may see buying interest due to fair valuation comfort amid an overbought market, said VK Vijayakumar, Chief Investment Strategist at Geojit Financial Services.

Valuation comfort in banking stocks

"Foreign institutional investor (FII) interest in HDFC Bank and ICICI Bank will be high as the buying spree begins due to their inexpensive valuations and wealth creation ability. Banking stocks will continue to fare well in the near-term due to their fair valuations in an over expensive Indian market," he added.

At current market price, the Bank Nifty index trades at 16 times (x) price-to-earnings (PE) ratio as against 23x PE ratio of benchmark Nifty 50 index, data suggested.

Ajit Kabi, Research Analyst at LKP Securities, added that private banks were trading at decade-low valuation given robust return ratios reported in the previous three years. “Hence, low valuation may drive the stock performance going forward.”

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The Bank Nifty index has gained 12 percent so far this year, to record highs above 48,500 points. This is against a 19 percent rise in NSE Nifty 50 this year. Punjab National Bank, IDFC First Bank, and IndusInd Bank are the top gainers on the Bank Nifty index for this year.

According to the RBI report, the gross non-performing asset (GNPA) ratio of Indian banks continued to improve in the second quarter of current fiscal year, easing to a fresh decadal low of 3.2 percent.

The consolidated balance sheet of banks expanded by 12.2 percent in FY23 -- the highest in 9 years, driven by credit to retail and services sectors. The report also showed that highest net interest income and lower provisioning led to a boost in net interest margin and profitability in FY23.

NPA cycle at the bottom, credit quality strong

Kabi of LKP Securities believes that the NPA cycle is at the bottom, and that the banks’ credit quality will remain intact in the coming quarters. "CY24 is unlikely to witness any major NPA formation," he said, recommending IndusInd Bank, ICICI Bank, Bank of Baroda, and Canara Bank from the banking space.

Further, the RBI report said that capital to risk weighted assets ratio (CRAR), a measure for capital adequacy of banks stood at 16.8 percent at the end of September 2023, with all bank groups meeting regulatory minimum requirement and common equity tier-1 (CET1) ratio.

Though the RBI's new risk-weight norms may dilute the capital adequacy of private banks due to their large proportion of personal loans and credit card outstanding, adequate capital may cushion the impact, said analysts.

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According to analysts at Motilal Oswal, public sector banks (PSBs) are poised for re-rating due to a steady earnings outlook. "Several PSBs have raised capital from the market and have shored up their capitalisation levels, which will enable healthy balance sheet growth, particularly as the capex cycle recovers after the general elections," they said in an earlier note.

The brokerage firm pegged PSBs to grow at a healthy 16-22 percent range over FY 2024-26, recommending SBI, Bank of Baroda, and Canara Bank as top picks.

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