Why the party is not over for bank stocks

Robust systemic credit growth, improved traction in retail loans, and a pick-up in corporate loans boosted the Q2 earnings of banks. In a rising interest rate scenario, the sector’s net interest margin (NIM) expansion was striking, with loans getting repriced faster than deposits. As a conscious strategy, banks are first absorbing internal liquidity. This is leading to a slowdown in raising deposit rates, said Emkay Global Financial Services Ltd.

Kotak Mahindra Bank’s managing director and chief executive officer Uday Kotak summed this up aptly, “We (banking industry) are probably in one of the most important Cinderella times of the credit cycle."

The clock for this Cinderella moment has started ticking, with systemic liquidity in tightening mode. However, there is some time before the party ends, as a full pass-through of rate hikes on the deposit front is yet to happen.

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Since May, the Reserve Bank of India has increased the repo rate by a cumulative 190 basis points (bps). Banks are upbeat on sustaining their loan growth trajectory, mainly on the back of expected traction in corporate loans. Most banks have raised their credit growth estimate for FY23 by 200-300bps, said the Emkay report dated 18 November.

The challenging part now is that deposits growth is muted and lags credit growth. However, banks are likely to raise deposit rates aggressively to fund credit demand. This means the fight for deposits would become intense.

“Within deposits, low-cost and current and savings account (CASA) deposits are showing weaker growth. In Q2FY23, many prominent large banks saw a drop in the CASA mix because of tighter monetary policy, which is now reflecting on the liquidity within the system," said Santanu Chakrabarti, India analyst, banking, financial services, and insurance, at BNP Paribas. Thus, if deposit growth disappoints, the fight for CASA and marginal spends around it would escalate, impacting the sector’s NIM. As such, deposit mobilization and the pace at which banks increase deposit rates are important parameters to watch out for, apart from trends in cost of funds.

The aforementioned scenario would unfold eventually; until then the comfort on NIM remains. “We expect NIMs to remain in good stead in H2FY23. Credit growth is expected to remain robust in H2FY23, given that Q4 is a seasonally strong quarter for the sector and some part of festival-led loan demand would have also flown into the December quarter," said Dnyananda Vaidya, research analyst at Axis Securities Ltd.

Further, as things stand, analysts are not too worried about the sector’s asset quality as incremental stress build-up is expected to be low. Meanwhile, mid-tier banks still have some scope for a valuation re-rating, said Vaidya. “Among large banks, ICICI Bank and State Bank of India are better placed on the valuation front than HDFC Bank, since the overhang of the merger would restrict a re-rating," she said.

Overall, investors in banking stocks are in a merry mood taking the sector index Nifty Bank to a new 52-week high on Thursday. So far in CY22, Nifty Bank has risen 21%, comfortably beating the Nifty 50’s 7% returns. But hold your breath. Note that banks are not immune to growth slowdown risks arising from further potential deterioration in macro-economic environment. Therefore, the party may continue, but may not last long.

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