Year Ender: Banking Sector In 2023—Witnessing A Sharp Drop/Hike In Interest Rates

The first half of 2023 saw an outstanding performance from banks, with NIMs rising and return ratios above historical averages-with PSU banks taking the stage. The banks saw the worst effects of a high-interest rate scenario in Q2FY24, as was to be anticipated, and the elevated cost of funding experienced a bearing on NIMs. However, the banks had an exceptional first half of CY23.

Indian Banks: CY23 review and CY24 outlook

According to Ajit Kabi, Research Analyst at LKP Securities, here is a valuation and outlook for the banking sector.

Business Momentum: The credit-off take for SCBs remains strong in CY23. According to the RBI announcement, in Oct-23 the gross bank credit grew by 19.7% YoY. Both public and private sector banks have performed well. Retail loan growth stood robust at 30.4% YoY, followed by the service sector (23.6%) and agriculture credit (17.5%).

Additionally, systemic deposit growth is in line. The PSBs have larger comfort for the CD-R ratio. We expect the loan growth to remain robust for CY24 given the election year, consumer demand and higher capital expenditure.

Margins: The policy rate remained unchanged since Feb-23. Liquidity measures like OMO and ICRR have impacted the margins of the banks. The cost of funds will be key monitorable for quarters to come. Moreover, the elevated operating expenses have dented the PPOP growth.

Nevertheless, lower credit costs have led to stable profitability and return ratios remain intact. We may witness further margin compression in the next quarter and stability at the end of FY24.

Asset Quality: The NPA ratio has improved significantly in CY23 driven by lower slippages and recoveries. We believe the NPA cycle at the bottom and the credit quality to remain intact in coming quarters. CY24 is unlikely to witness major NPA formation.

Capital Dilution: Higher risk weight to unsecured loan will dilute the capital adequacy. The private banks having a large proportion of personal loans and credit cards outstanding will witness a major impact. Nonetheless, they have an adequate capital cushion to handle it.

Valuation comfort is the key: The private banks are trading at decade-low valuations given robust return ratios reported in the previous three years. Hence, the low valuation may drive the stock price performance.

Preferred Picks: We are recommending IndusInd Bank, ICICI Bank, Bank of Baroda, and Canara Bank, said Ajit Kabi.

Banking Secor Outlook For 2024

Swapnil Shah, Director-Research, StoxBox said, "Banks performed exceedingly well in the first half of 2023, with NIMs expanding and return ratios exceeding their historical averages especially the PSU banks stealing the limelight.

As expected, the banks faced the brunt of a high-interest rate environment in Q2FY24, and NIMs were impacted due to the high cost of the funds, but the first half of CY23 was outstanding for the banks. Also, 2023 had robust profitability seen across the banking vertical mainly due to a decreasing trend in the provisions aided by stable asset quality and robust credit growth."

"Additionally, the banks have seen an increase in unsecured loan books which contributed to the bank's robust profit due to higher yields generated by the segment. With the rural economy showing signs of improvement and an increase in demand for unsecured loans with improvement seen in the housing segments, the bank posted good results in 2023.

With the effect of interest rate hikes passed and the interest rate environment peaking, we believe that banks will have some NIM compression going forward. However, business growth for banks remains intact which in turn will show an increasing trend in the bank's absolute profitability," stated Swapnil Shah.