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Kotak Mutual Fund

Banks will soon start announcing Q1FY21 results. While you analyze their performance this time, you need to pay attention to their growth preferences and fund raising plans, besides COVID-related provisioning. Our primary pre-result-analysis suggests that the large private sector banks are likely to gain market share now and in future if they play their cards well during this pandemic.

Recently, RBI extended the EMI moratorium for another three months beyond August 31st 2020—one more round!  With lockdowns now moratorium is getting extensions too. While this offers a much needed relief to borrowers, experts believe the possibility of loans under moratorium turning non-productive is now getting too close to fatality.

S&P has already warned that NPAs in the Indian banking system are likely to touch a two-decade high with bad assets mounting to 13%-14% of total advances in FY21.

The COVID-19 pandemic may set back the recovery of India's banking sector by years, which could hit credit flows and, ultimately, the economy, cautioned S&P. 

Taking cognizance of the situation, RBI has also advised banks and Non-Banking Financial Companies (NBFCs) to take stress tests. Banks are also advised to take adequate steps to palliate the potential COVID-inflicted rise in NPAs.

Markets too seem to be worried about the prospects of the banking sector. Nifty Bank massively underperformed the bellwether index, Nifty 50, on a Year-To-Date (YTD) basis. More so, the sector has been a laggard even during the market recovery phase—despite having a slightly upwards of 1/3rd of weightage in Nifty 50.

Is this a permanent dislocation?  

Now that we are approaching the earnings season, investors might be feeling jittery about (negative) surprises that banks might have in store. The going will only get tougher for Indian banks; no two opinions there. However, if you go overboard with the gloom and pessimism prevalent everywhere, you might miss the big picture—a prerequisite for taking a well informed decision.

If you remember, in the post demonetisation times, independent credit rating agencies shared a similar view and expected NPAs to go through the roof. But the situation at the grassroots level didn’t turn out to be as bad as they anticipated.

This is not to say that the independent rating agencies will go wrong this time too; it just means you shouldn’t let the pendulum of your opinion swing 180 degrees based on what “experts” feel. As they say, in this market there’s only one expert—the market itself!

So how should you analyse a banking stock and its earnings on the backdrop of the COVID-inflicted slowdown?

3 factors to watch out for:

  • Credit growth
  • COVID-related NPA provisioning (and loan book under moratorium)
  • Capital adequacy

Credit growth

For the past few years, credit growth in India’s banking system has been anemic yet a few banks have managed to grow at more than twice the average credit growth rate of the industry. Some of them managed to maintain their asset quality while others witnessed a massive spike in NPAs which pushed them close to bankruptcy.

In FY20, Indian banks witnessed an average credit growth of 9.0%. However, in the Q1FY21, the credit growth has skid to 6.8%. Hence, one needs to carefully monitor the outlooks of banks on credit growth in FY21.

During the lockdown period, quite a few banks preferred to sit tight on funds, rather than lend. Because of their risk-averseness, at one point, deposits of banks with RBI under reverse repo jumped to Rs 8 lakh crore. But there are always exceptions.

According to disclosures made to exchanges, HDFC Bank—a synonym to retail banking in India—expanded its loan book by 21% and also witnessed a jump of 25% in deposits. This is a clear indication that the bank has grabbed some market share from competition on both fronts.

Now if it can contain NPAs in the subsequent quarters, why won’t the Bank emerge stronger?

At the industry level, unless credit growth picks up and gets into low teens, India is unlikely to see a V-shaped or a U-shaped recovery with a small base. It’s interesting to see if large private sector banks confine themselves to retail loans or they get into financing the working capital requirements of corporate and MSMEs—a segment which is likely to create a huge demand.  

Asset quality

On an average, banks have 20%-30% of their loan books under moratorium, in the case of some Non-Banking Financial Companies (NBFCs), this proportion is over 70%. As long as a bank you are analysing doesn’t touch some extreme and remains close to the industry average, you need not worry. In this case, you should check the provisioning coverage ratio (PCR) of the bank and its track record on the NPA front.

The industry has collectively provided Rs 13,653 crore for COVID-related delinquencies.

As on September 2019, the total SMA (Special Mentioned Accounts) book—accounts having delinquencies but not classified as NPAs—of Indian banks was Rs 3.25 lakh crore, of which 0.96 lakh crore was SMA-2. Banks will have to carefully monitor SMA-2 part of their loan books. Any commentary on SMA book and moratorium shall be read as a whole and not in parts.

Capital adequacy

Unless a bank is adequately capitalized, its risk absorption ability remains low, which endangers its goodwill and sometimes even existence. Some leading banks in India are treating the ongoing crisis as an opportunity, and raising capital (despite being well capitalized) and are gearing up for the next leg of growth, beyond the pandemic. Moreover, raising capital at this juncture might help these banks tackle the potential NPAs more effectively.

In summary

COVID-19 is one of the worst medical and financial crises in the last 100 years, as rightly described by RBI. However, this extra-ordinary situation will test how mature India’s banking sector is. Banks that can remain relatively unscathed not only may gain market share but can also grow exponentially, if well capitalized.

It looks like the dominance of large private banks is here to stay—monitor their Q1FY21 performance meticulously.

You may also like to read: When stimulant becomes depressant for banks



We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.


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