Indian banks well placed with strong balance sheets, record profits, cheap valuations: CLSA; likes IndusInd, ICICI Bank

Indian banks have established themselves on a much stronger footing led by cleaner balance sheets, record profits and inexpensive valuations, foreign brokerage firm CLSA said.

“We believe Indian banks are well placed after a rollercoaster decade. Balance sheets are the strongest they have been in over a decade and profits have rebounded sharply (quadrupling in 10 years),” CLSA said in a report.

It noted that the return on equity (ROE) of the Indian banking sector at 15% is the highest since the Financial Year 2010-2011. The net NPL/net worth ratio of the banking sector has declined to decadal lows, driven by better asset quality, stronger provision buffers and an improved capital position. PAT for the sector has rebounded sharply and has quadrupled over the past decade.

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“In this context, PSU Banks have re-rated sharply from a low base, while private sector banks have been laggards. We expect the underperformance of the latter to reverse,” CLSA said.

Moreover, the banking sector loan growth has picked up from a decadal average of 10% to 15% over the past two years driven by all sub-segments and possibly some shift from corporate bond substitution.

While CLSA expects a degree of normalisation in unsecured loan growth from 20%+ to mid-to-high teens, it estimates overall loan growth at 14-15% over the next two years.

“We expect private sector banks to continue gaining market share. However, FY25 loan growth across our coverage banks is likely to be divergent due to idiosyncratic issues,” the brokerage report said.

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Meanwhile in the past two years, lower deposit growth could be attributed to lower reserve money growth, which CLSA’s India economist expects will pick up. One notable trend over the past decade is that private sector banks have outpaced PSU Banks in current account (CA) deposits by a margin and have also pared down non-deposit borrowings. This gives them a funding cost similar or marginally better than that of PSU Banks, making them competitive on the loan side.

Banks have underperformed the broader index by a wide margin in the past five years. Specifically, this is driven by private sector banks that have underperformed PSU Banks by 80 ppts in the past year alone.

CLSA believes private sector banks, which have been stock market laggards, should now give better returns given a good business outlook and inexpensive valuations (10-15x PE versus the Nifty 50 at 18x).

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The key short-term risk is a sharp repo rate cut that would reverse the net interest margin (NIM) improvement banks have delivered.

Among the large banks under its coverage, CLSA expects ICICI Bank to deliver the highest ROE (16-17%). While Kotak Mahindra Bank has a high ROA, its low leverage results in a low ROE. HDFC Bank’s lower ROE is due to the NIM impact from the merger, it said.

CLSA likes large banks with a preference for ICICI Bank and IndusInd Bank.

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