India Banks - Withstanding macro headwinds

We change our stance on Indian banks to Overweight from Underweight, given our expectation of robust profitability led by improvement in credit demand and stable asset quality. While macro concerns especially on liquidity and inflation would persist, we expect improvements in both.

n       Macro headwinds. Over the next 12 months, we expect average inflation to soften but remain well above the past-decade average. While the tight monetary policy bias would continue, near-term rate hikes would be modest and front-loaded. Although we expect easing of liquidity, it would largely remain in the deficit mode.

n       Bank efficiency and structural issues. Our quantitative study confirms impact of bank efficiency on valuation. We identify inefficiencies of PSU banks in deposits & branch utilization and non-interest income generation. We show that bank consolidation is unlikely to improve India 's banking sector efficiency.

n       Robust profitability likely. Improvement in the capex cycle would drive credit demand and yields higher, but a stretched cost-deposit ratio and low excess SLR would keep margins in check. Given the recent credit growth slowdown and better industrial outlook, we expect significantly lower credit costs as banks' asset quality issues subside. Recent capital infusion, particularly in PSU banks, would support business growth and profitability.

n       Scope for valuation upside. Most banks are trading at the mean of their past average valuations. Likely better business growth, stable margins and lower credit costs would improve valuations.

 

Safe Harbor Statement:

Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.

 

Nothing in this article is, or should be construed as, investment advice.