Large-cap lenders vs mid-cap banks: Which ones should you pick for long term?

Although the banking sector has lagged behind the Indian benchmark Nifty index over the past 6 to 12 months, it is well-positioned for substantial long-term growth, driven by India's largely underbanked population.

In 2024, the Nifty Bank index has risen over 8 percent year-to-date, trailing the benchmark Nifty's almost 13 percent increase. Meanwhile, over the past year, the Nifty Bank index has gained over 14 percent, compared to the Nifty's approximate 24 percent rise.

Within the banking sector, private banks have undergone a more pronounced correction compared to their public sector counterparts. Nevertheless, analysts expect a recovery for the overall banking sector in the near future.

So between blue-chip lenders and mid-cap banks, which ones should you pick for the long term?

Constituents

Among banking stocks, large-cap lenders have witnessed mixed returns. ICICI Bank and Axis Bank have risen 25 percent and 17.5 percent, respectively in 2024 YTD. Meanwhile, Punjab National Bank and SBI have also advanced 22 percent and 38 percent, respectively. Bank of Baroda also added over 8 percent each. However, IndusInd Bank shed over 10 percent, HDFC Bank was down 6 percent and Kotak Bank declined 5 percent in this period. 

Mid-cap banks have also given similar returns but delivered better performance than large-cap ones. Indian Overseas Bank is the top gainer, up almost 51 percent, followed by Punjab & Sind Bank, which rallied over 48 percent and Bank of Maharashtra, which jumped 46 percent. Federal Bank rose 23 percent and City Union Bank was up 4 percent this year so far. However, Bandhan Bank shed the most, down around 21 percent, followed by IDFC First Bank and RBL, down over 14 percent each.

Blue-chip lenders or mid-cap banks? Which ones should you pick? Here's what experts say:

With varying opinions from industry experts, the debate centers around stability, growth potential, and risk tolerance. This article summarises insights from key analysts to help investors make an informed decision.  

Raj Gaikar, Research Analyst, SAMCO Securities, prefers large-cap lenders over mid-cap ones.

Mid-cap lending companies are targeting underpenetrated niche segments, which are relatively riskier compared to the customer base of large-cap lenders. Given that, the market is currently overvalued and the mid-cap lender companies may face a correction, investors with low-risk tolerance should avoid investing in mid-cap lenders for now. Currently, large-cap lenders are undervalued and are likely to deliver better performance in the near future. However, investing in mid-cap lenders could help investors generate alpha over the long term.

Dnyanada Vaidya, Research Analyst - BFSI at Axis Securities, also likes large-cap lenders better.

Private banks, we believe, are currently trading at attractive valuations due to their strong growth runway and steady performance delivery potential. This stability leads us to prefer larger banks over their mid-sized banking peers. However, among the mid-sized banks, we like Federal Bank.

Jignesh Shial, Director - Research; Head of BFSI Sector at InCred Capital, as well emphasises a preference for large-cap banks.

Large-cap lenders remain our preferred pick over mid-cap lenders as we believe it to be a safer bet given the rising concerns in smaller ticket lending.

Ajit Mishra - SVP, Research, Religare Broking, also advised prioritising large-cap lenders over mid-cap ones.

Given the current market conditions, investors should prioritise large-cap lenders over mid-cap and small-cap lenders. The latter are trading at high valuations, presenting significant risks in the event of market corrections. Large-cap lenders, on the other hand, offer greater stability, better risk management, and are well-equipped to handle regulatory changes. Moreover, large-cap banks have a consistent history of paying dividends and returning value to shareholders, making them a more prudent investment choice.

Vaibhav Jain, Head of Content & Education, Share.Market, suggested investors to maintain a focus on large-cap lenders.

Lending is a high-beta business, meaning lenders tend to perform exceptionally well during economic expansions but can suffer significant losses during downturns. For those willing to take higher risks, investing in mid-cap lenders can yield substantial returns in good times but can also lead to severe losses in bad times. Smaller lenders have higher growth potential but also face significant asset quality issues.

When comparing large-cap and mid-cap lenders, it's clear that mid-cap lenders inherently have more quality issues. They deal with higher costs of funds, higher yields on loans, and consequently, higher NPAs and provisions. This is reflected in the Quality factor scores, where large-cap lenders consistently outperform their mid-cap counterparts.

Investing in mid-cap lenders would only be justifiable if they had strong Sentiment and Momentum factors. However, a close examination of these scores reveals that mid-cap lenders currently lack strong momentum and sentiment. Without these supportive factors, mid-cap lenders do not present a compelling case, as they offer no significant upside potential and lack protection against downside risks should economic conditions worsen.

Therefore, it is suitable for investors to maintain a focus on large-cap lenders. These institutions offer more stability, better quality, and sufficient upside potential without the excessive risks associated with mid-cap lenders.

Atul Parakh - CEO, Bigul, advocates for a balanced investment approach.

Investors should consider a mix based on their risk profile. Large-cap lenders are generally more stable with lower volatility, better placed to weather economic cycles, and often have stronger balance sheets. Mid-cap lenders typically offer higher growth potential, may offer better returns in bullish markets, and are often more nimble in adapting to market changes. A balanced approach might involve a core allocation to largecaps for stability, with some mid-cap exposure for growth potential. The ratio would depend on individual risk tolerance and market conditions.

The choice between large-cap and mid-cap banks largely depends on individual risk tolerance and investment goals. While mid-cap banks may offer higher growth potential, they come with increased volatility. On the other hand, large-cap lenders, generally provide greater stability and consistent performance. For investors seeking safety and reliable returns, large-cap banks are the preferred option. Conversely, those willing to take on more risk for potential higher returns might consider mid-cap lenders, provided they closely monitor market conditions and the specific performance of these institutions.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.