The sector indices for banking and finance companies have underperformed the benchmark indices over the past three months, six months and 12 months reflecting broader concerns such as margin pressure, slowing deposit growth and regulatory changes. With relatively lower valuations at a time when most other sectors look richly valued, it makes sense for investors to evaluate the industry to find investment opportunities.
Among the major factors that have weighed on the lending sector, regulatory changes and slow deposit collection are major causes for concern. In a bid to avert a possible systemic impact, the Reserve Bank of India (RBI) in recent months has clamped down upon the segment of unsecured loans and lending of banks to non-banking financial companies (NBFCs). As a result of stringent measures such as higher risk weights for unsecured loans, credit growth fell to around 14% year-on-year in June 2024 from 16% a year ago. In addition, NBFC lending from banks shrank to 8% in June from 15% three months ago.
“As unsecured credit growth declines, impact on net interest margins (NIMs) for banks remains a key monitorable. Further, there are signs of over-leveraging and an increase in stress in this segment which could increase credit costs in the near term,” Suresh Ganapathy, financial services research head, Macquarie Capital, said in a note.
Besides, the changes to the liquidity coverage ratio (LCR) by the RBI are expected to result in a tighter funding environment for banks. “This is the biggest challenge today in the banking system and an even more difficult situation for NBFCs as 50% of funding for them comes from banks,” said Ganapathy, adding that new LCR rules will likely result in more investment in low-yielding government securities thereby impacting margins further.
Rating agency CareEdge said in a report that the credit offtake has lagged deposit growth in recent months and hence the credit-deposit ratio derived from these flows from January would be around 70%, and from March would be approximately 54%. “This indicates that the bank credit offtake could face challenges and is likely to be tepid for the year,” said the rating agency.
These factors are likely to impact the NIMs in the short term even though several banks have shown a near stable trend in margins in the June 2024 quarter after reporting pressure in the previous few quarters.
Against this backdrop, investors need to observe caution while considering the stocks in the banking sector. “Private sector banks can generate 16-18% return on investments and are available at reasonable valuations,” said Ganapathy.
