Nitin Bhasin, Co-Head and Head of Research, and Pankaj Agarwal, Analyst (Banking & Financial Services) at Ambit Institutional Equities
Contrary to fears, the Indian banking sector has emerged largely unscathed from the COVID crisis. In fact, the sector is going through one of the best phases during the last decade with accelerating credit growth and falling non-performing assets (NPAs).
Acceleration in credit growth across the board
Credit growth has been accelerating for Indian banks over the last year with YoY credit growth hitting a 10-year high of 15 percent in August 2022. We expect the credit growth for the sector to sustain going forward due to (i) Broad-based nature of the growth; (ii) some market share shift from corporate bonds to banks; (iii) increasing capacity utilisation/capex in the manufacturing/industrial sector.
The acceleration in credit growth over the last year is across retail, services, industries and agriculture. Further, drilling down suggests that growth is accelerating in all sub-segments in each category rather than being confined to any particular category. In retail, growth is accelerating in home loans as well as credit cards. Within services, growth is accelerating in trade as well as transport operators.
Within the industry as well, growth is accelerating across industries - from Infrastructure to metals to food processing. There were some concerns that growth in credit is driven by working capital loans and public sector entities. However, incremental loan disbursement over FY20-22 shows that growth is across the public/private/household sector and term loans/working capital loans.
RBI data shows that there is a high correlation between industry capacity utilization and industry credit growth. There are some signs of capacity utilisation picking up and should help growth in industrial credit. Our Infra/steel/cement research team is seeing cost and energy efficiency related capex trickling back in steel/cement sector and some PLI (product linked incentive scheme) related capex in the manufacturing sector. If we look at long-term trends in industrial credit to Industrial GDP, the ratio is at pre-GFC levels implying low leverage levels in the industrial sector. Hence, there is scope for this ratio to increase from hereon.
Apart from general buoyancy in credit demand, banks are also benefitting from corporate credit demand shifting back to banks from the corporate bond market. Bond yields softening over FY20-22 had resulted in large high-rated corporates moving away from bank borrowings to the corporate bond market. However, the difference between 1-year AAA bond yield and 1-year MCLR (or base rate) rate has disappeared over the last six months, which is bringing back corporates to banks.
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Improving asset quality- well-provisioned loan book
Despite the onslaught of COVID, the asset quality of Indian banks has been consistently improving from FY18 onwards. From a peak gross NPA ratio of 11.2 percent in March 2018, the gross NPA ratio has come down to 5.9 percent in March 2022. The majority of the improvement has been due to a sharp reduction in NPAs in the corporate segment.
However, contrary to fears, the retail asset quality for banks did not deteriorate much during COVID and started improving from the second half of FY22 onwards. Multiple data show that the asset quality of Indian banks should be stable in the near future. The new NPA formation for banks has been lower over the last 4 quarters even compared to pre-COVID levels.
The banking sector's provisioning coverage is around 75 percent, the best in the last decade. The restructured loan book of banks is just around 1.5 percent and banks have extra provisions to take care of any NPA formation from this restructured loan book. However, sustained weakness in the global and Indian economy can lead to a new wave of NPAs for the sector a year down the line and has to be watched closely.
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Deposit growth can play a spoilsport
Given tightening liquidity, deposit growth for the banking sector is lagging at 8 percent YoY (versus 15 percent YoY growth in credit) and can play a spoilsport for banks' profitability. Banks have used the liquidity they were carrying to fund the gap between credit and deposit growth till now. However, this extra liquidity would be exhausted by September 2022. Hence, post that banks will have to increase their deposit rates significantly to bridge the gap between deposit and loan growth.
Though technically, banks can pass on the increase in the cost of funds to their customers, it might not be feasible in reality. Given the general weakness in the economy and competition within banks on the lending side, banks might need to absorb these additional costs of funds and take a hit on their NIMs.
Reasonable quality at a reasonable price
Despite improving fundamentals for the banking sector, margin compression is likely for the sector going forward. Moreover, sustained weakness in the global and Indian economy may play a spoilsport on growth and asset quality as well one year down the line. Hence, in this backdrop, we recommend buying quality at a reasonable price in the sector. We would avoid expensive stocks in the sector and weak banks despite cheap valuations. Axis Bank, SBI, and Federal Bank fits our conviction buys in the sector.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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