In a remarkable turn of events, public sector banks in India have emerged as stock market favourites, defying historical challenges and attracting significant investor interest.
Nifty PSU Bank, after generating 8 multibaggers in a year, is now poised for a potential 13-year breakout, which could propel the index to new all-time highs. Currently, as of Wednesday’s close at 5,233, it sits below the closing peak of 5,375.8 recorded in November 2010, compared to Monday’s closing level of 5,217.
In contrast to private sector banks, PSU banks have outperformed, with some posting remarkable returns. While private sector banks like HDFC Bank and Kotak Mahindra Bank delivered respectable returns, PSU banks like UCO Bank and Punjab and Sind Bank have seen their stock prices soar, registering multifold gains.
The resurgence of these government-owned banks can be attributed to a confluence of factors, including improved asset quality, successful mergers, and a more favourable regulatory environment.
For years, PSU banks in India grappled with issues like high levels of non-performing assets (NPAs) and operational inefficiencies. However, a transformative journey that began in 2015 with the asset quality review (AQR) initiated by the Reserve Bank of India (RBI) marked a turning point for these institutions. The AQR led to a rigorous cleanup of bad loans, fundamentally altering the landscape for state-run banks.
Improved asset quality
The AQR, along with concerted efforts by these banks, resulted in a notable reduction in gross NPAs. From a peak of 14.6 percent in March 2018, the gross NPAs of PSU banks declined to 5.53 percent by December 2022. This remarkable improvement in asset quality restored investor confidence in these banks.
One of the pivotal moments in this transformation was the mega-merger of public sector banks in 2020. Under this consolidation plan, several banks were merged to create larger, more robust entities within the public sector. Banks such as Punjab National Bank, Canara Bank, Indian Bank, and Union Bank of India witnessed significant improvements in profitability and asset quality as a result of this initiative.
Diversification and policy support
PSU banks have adopted a diversified approach to their portfolios, mitigating stress and reducing risk. Policy decisions, including regulatory changes, have also worked in their favour. These measures have bolstered their lending practices, with banks providing more credit while maintaining healthy asset quality.
One crucial aspect of their resurgence is the prudent use of loan write-offs and robust recovery mechanisms. Banks have transparently recognized and reclassified standard restructured advances as NPAs, providing for expected losses. This approach, combined with actual loan recoveries, has contributed to the banks reporting healthy asset quality figures.
Strong credit growth
The credit offtake for these banks continued to grow at a rapid pace, driven by factors such as HDFC’s merger with HDFC Bank and growth in personal loans. Excluding the merger impact, credit growth remained strong, indicating the banks’ resilience and ability to attract borrowers.
Deposits have also witnessed substantial growth, reaching a six-year high. Banks have focused on strengthening their liability franchise to ensure deposit growth supports their expanding credit portfolios.
The future
Market analysts maintain a positive outlook on PSU banks, emphasizing that valuations remain reasonable. Many PSU banks are expected to deliver a healthy return on assets (ROA) over the next 12 to 24 months, making them attractive investments.
However, experts caution that economic factors such as inflation and policy rates may still impact the financial system and banks. They advise vigilance in the face of potential challenges, including a possible uptick in NPAs and margin squeezes in the near future.
