Dear Reader,
India’s listed banks have reported stellar growth in profits quarter after quarter for the past four years. Most bank chiefs have indicated a healthy outlook for FY25 too, albeit acknowledging the pressure on margins and the fight for deposits.
But shares of banks have been big underperformers when compared to the broad market indices. The Nifty has gained roughly 25 percent over the past one year, but the banking index has crawled about 10 percent. This is despite public sector banks notching historic gains on the back of record improvement in their return ratios. Indeed, the Nifty PSU Bank index has clocked a colossal 79 percent gain.
The culprits are private sector banks. Once the apple of investors’ eyes, private sector lenders have become laggards in almost all metrics. Emkay Global’s head of research Seshadri Sen brings out this trend in a report aptly titled “Waiting for Godot: the elusive turnaround”. Sen points out that private sector banks are “ex-growth” and no longer belong in the growth stocks group. These lenders face headwinds in revenues, profits and even book value per share over the next one year.
Multiple factors are working against private sector banks but the biggest is regulatory punishments. HDFC Bank was the first to be pulled up for lapses in digital products and credit cards back in December 2020. It took the bank nearly a year to resolve all issues for the removal of business restrictions imposed on it by the banking regulator. It does not help investors that HDFC Bank’s, the largest private sector lender, is an index heavyweight stock in the market and has lost 10 percent of its valuation in the past one year.
HDFC Bank was followed by Bajaj Finance and finally Kotak Mahindra Bank for punitive action by the regulator. As such, the Reserve Bank of India (RBI) has been tightening rules for the banking sector. Recall the hike in risk weights on unsecured loans, the tightening of rules regarding credit cards and finally proposal to make norms on project finance stricter. “The era of quality private banks delivering predictable growth, irrespective of the external environment, is over,” says Sen.
The upshot is that banks have hardly any options of lending where they can get more bang for every buck they lend. The aggression on margin friendly retail unsecured loans has reduced, credit cards too are being handled cautiously. Wholesale lending is yet to take off meaningfully because of banks’ reluctance given the previous credit cycle. Demand for credit from firms is also not strong enough as private capex is yet to gain traction and most large companies are opting to borrow from the bond market. That leaves banks with limited options to grow their income. At the same time, operating expenses are going to remain elevated because of spending on technology, especially when the RBI is watching like a hawk.
Public sector banks are better placed to gain market share in profitable segments such as retail loans and even select wholesale lending. There are always the lucrative small business loans that almost every bank is chasing today. But they too are struggling to raise deposits, a challenge felt across the industry.
In short, the banking sector’s fun times are almost over. Even if bankers are sanguine and believe that the market isn’t ascribing a fair value to their stocks, there is very little powder left to fire up return ratios even more. In Emkay’s opinion, fair value multiples have collapsed. Sen points out that despite this, Indian banks are trading at a premium compared with their international peers.
That means premium valuations of banks are at their peak and there is only one way to go: down. Financials have powered much of the rally of the stock market in the recent years. With the banking festivities nearing its end, is it time for the broader market to open the exit door?
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