The rally in the Banking, Financial Services, and Insurance (BFSI) sector is expected to be short-lived, driven primarily by a potential recovery in deposit growth as the Reserve Bank of India (RBI) embarks on its easing cycle. According to a note from Emkay Global Financial Services, while the sector appears to be enjoying a moment of optically moderate valuations, this rally may not extend beyond the next quarter.
“We see this as a short-lived rally. Rate cuts in 3QFY25 would lead to margin cuts in 4QFY25 for most major banks, given that mortgages (~30% of loan book for most large banks) re-price immediately. Also, banks may delay deposit rate cuts due to the recent tightness and HDFC Bank’s need to replace deposits of the erstwhile HDFC Ltd borrowings,” the report said.
As the RBI prepares for an accommodative stance, possibly initiating its first rate cut between October and December 2024, analysts predict an acceleration in deposit growth. However, they caution that this uptick will be countered by margin pressures once repo rates are lowered. The note highlights that current valuations in the BFSI sector, standing at 2-2.8 times price-to-book value (PBV), remain overvalued compared to their fair-value ranges of 1.5-1.7 times PBV.
Liquidity and market dynamics
The easing of domestic liquidity has historically served as a potent catalyst for lenders, and the current narrative surrounding a deposit shortage is expected to amplify this effect. The slowdown in deposit growth closely follows trends in M3 growth, and analysts anticipate a rebound in deposits once the RBI shifts its monetary policy. The note suggests that the positive triggers from easier liquidity could sustain the short-term rally, even as the overall market pushes large segments into overvalued territory.
“1YF Nifty PER is up 46% to 24x since Mar-23. This has pushed large parts of the market into overvalued territory. On the other hand, the PER for Financials has seen its discount to the Nifty PER expand, from 20% to 25% in the same period. IT is also the cheapest sector in the Nifty, barring energy. Lack of options for investors looking for reasonable valuations combined with the positive trigger of easier liquidity is pushing the short-term rally in Financials,” the Emkay report said.
