Going Digital : The Growth Mantra

Banking stocks are always in the news and there is never a dull moment for an investor who has sizeable investment in banking stocks. Amit Dueskar, who has been holding banking stocks for more than a decade, says “I have been hugely rewarded for holding on to private banks for so long. I closely witnessed various growth cycles for some of my holdings (in banks). While I am happy I had more than 25 per cent weightage of my portfolio in banking stocks, I do not know if I can still continue to maintain a higher weightage for banking stocks. Investing in banking space has become a tricky affair now and it's really difficult to ascertain the growth and quality for these highly competitive banks. Banking stocks have become extremely volatile.”




Indeed, the banking sector today is more disruptive in nature than in its entire history of existence. The confluence of various developments in the digital solutions, cryptocurrencies, NPAs and its impact on quality of assets for banks are influencing the strategic outlook for several banks in India. While cryptocurrencies are not threatening the way the banks work, it has shown the importance of blockchain technology and its utility in the banking sector. 



Ideally, being in operation in the world's fastest growing economy, the banking sector in India should be thriving and growing with an accelerated pace. However, it is ironical that the sector that is supporting the fastest growing economy in the world is struggling to remain strong and resilient in recent times. The burden of distressed assets is what is pulling the banking sector growth down in India. The NPAs grew at 25 per cent per annum from 2013 to 2017.

The PSU banks account for more than three-fourth of the stressed assets and the worrying aspect is that the amount of stressed asset is now more than the net worth of these banks. A look at the numbers declared by the banks do not reflect their true health. The problems facing the private banks are less severe when compared to those faced by the PSU banks.

In spite of the banks being under pressure due to stressed assets and the stagnant loan growth, the banking sector in India remains one of the world's biggest opportunities. The macroeconomic strength of India is intact and, as a nation, we are in the throes of a digital revolution. Both these developments aided by shift in the stance on regulatory front indicate that there could be new entrants in the sector. The strong macroeconomic fundamentals suggest that there are enough opportunities for the new banks as well. The sector should do well in the coming years.

Due to inefficiencies and inability to penetrate faster, PSU banks over the years have been steadily losing market share both to the private banks and NBFCs. NBFCs have been facing liquidity problem recently that have taken market participants by surprise. The large banks have been acting as lenders of last resort to the growing NBFCs. However, after the ILFS fiasco, the large banks have stopped lending to the NBFCs across the board. NBFCs are instrumental in financing the growing aspirations of SMEs in India. The liquidity crisis dogging the NBFCs is threatening the very durability of the growth of financial services sector in India, which also impacts the growth story of banking sector in India.



Digital banking: The future of banking in India
Increasingly, more and more business is done via mobile and the same applies for banking transactions. The digital revolution is making banks and other financial institutions more efficient and effective in their operations. For those banks that have shown leadership in technology, the future looks bright. Mobile technology has raised productivity for banks and enhanced customer experience. It is indeed digital transformation that is a key priority for bankers.

{Fintech :- Fintech or financial technology is used to describe new technology that helps to improve and automate the processes in financial services company. Fintech helps companies, business owners and consumers to manage financial operations and processes. Fintech includes technological innovation and automation in the financial sector, including financial education, wealth management processes, lending and borrowing process, retail banking activities, payments and money transfers and investment management processes.”}


Fintech is the buzzword for banks and financial services. According to E&Y report, 62 per cent of global banks expect to be digitally mature in 2020 compared with just 19 per cent in 2018. In the coming years, the key business priority for banks is expected to be implementation of a digital transformation programme and, as an investor, one can expect banks to be digitally mature in three to four years from now. Digital maturity in banks will bring in more efficiency and effectiveness in banking operations, thus making banks more profitable.

Fintechs are increasingly shaping the way leads are generated and the way banks and NBFCs are interacting with the consumers. More and more small finance banks and NBFCs are seen capitalising on the fintech revolution and tapping higher businesses. For both small finance banks and NBFCs, being digital and optimally using FinTech has become essential for survival.

Small finance banks have been reflecting above average growth rates in advances. Going forward, the growth can be seen in small finance banks that are able to exploit technology optimally.

Sunil Agarwal
Managing Director, PAISALO Digital Limited.

What is your view on the liquidity crunch facing the NBFC sector?

NBFCs are certainly facing liquidity crunch and with the PSU banks in bad shape, the market has shifted to NBFCs for credit need. Unfortunately, banks who act as wholesalers are treating all NBFCs with the same yardstick and NBFCs with long-term track record and lesser debt-to-equity ratio should continue to be supported. There is definitely a need to review the credit facilities to large NBFCs with complex subsidiary structure and pure NBFCs with retail focus and without any scope of diversion of funds should be supported by credit facilities immediately.

How is the growth in advances for the SME sector?
SME sector is growing as the Indian entrepreneurial skills are well-known. The SME sector has become lifeline of our large population and thus the credit needs of SME sector is to be dealt with a very positive attitude. There is liquidity crunch and large payments are stuck up with very large organisations, including government departments. The need of working capital has gone up due to GST implementation as well. The SME sector demand for advances is up and there is supply shortage.

Are banks lending to NBFCs? Are you able to raise funds from banks?
Banks are only lending to very large NBFCs. Mid-size NBFCs are finding it difficult to even draw their sanctioned but unveiled lines. We are unable to raise funds from banks ever since ILFS fiasco happened. Treating ILFS as a NBFC, wherein the entire borrowed money was used for self-promoted or associated projects, is wrong and ILFS should be treated as an infra company not a NBFC.

Prakash Sundaram
Chief Strategy Officer, Fincare Small Finance Bank.

Is digital banking fast, cheap and productive for Fincare?

Definitely. Digital banking helps with taking instant credit decisions through real time credit bureau integrations and use of alternative data sources for credit scoring. It also helps open accounts, do transactions and fulfil service requests instantly, through the assisted service and self-service modes. Use of digital solutions helps reduce the need for a) paper-based processes, b) manual verification through built-in validations and real-time integrations, and c) back-end processes. These solutions also help improve employee productivity by reducing the effort involved in opening an account, enabling field teams to focus on servicing, cross-selling and catering to more customers.

What kind of growth in deposits and advances are you aiming for in the coming three years?

By 2021, we are looking to grow our deposits and our gross loan portfolio to about Rs.10,000 crore each.

What are the growth drivers for your company?
On the lending side, Fincare’s target segments are rural low income households that we service through our microloans, and micro and small enterprises that we service through our loans against property. Both of these segments are significantly un-served or under-served, with a large credit gap. To be specific, according to ICRA research, while the MFI industry in FY18 was a little over Rs.2 lakh crore in size, the credit gap in the sector is about Rs.5-6 lakh crore, with the gap in the rural segment alone being Rs.4.5 lakh crore. Likewise, the IFC has estimated that the finance gap in the MSME segment in India is about Rs.16 lakh crore. As you can see, the opportunity is very large. These segments are also under-served from a point of view of penetration of savings, insurance and other financial services products.

Apart from these external factors, Fincare’s presence in deep rural pockets, innovative digital solutions that can deliver instant credit decisions and open instant accounts, partnerships that enhance our product suite and distribution network and convenient banking through doorstep delivery and self-service modes will drive growth.

What are small finance banks ?

{Small finance banks are allowed to take deposits from customers and are allowed to lend money to people. 
Small finance banks that have received 'in-principle' nod from RBI are micro-finance institutions. Maximum customers of the small finance banks account for small and medium enterprises and small businesses. 
Small finance banks can provide secured and legal loans to MSMEs and SMEs. To increase financial inclusion, the small finance banks were given permission to run businesses in India. Small finance bank is a step to bring the unbanked under the ambit of the banking system. Small finance banks aim to provide banking products to the under-served and under-reached sections of the country, including micro and small industries, small and marginal farmers and other organised sector entities at an affordable cost.}



Vineeta Sharma

Head of Research, Narnolia securities

From a long-term perspective, we remain confident on value migration from PSU banks to private sector banks considering the aggressive advances growth, increasing penetration by branch expansions, better asset quality, product diversification and technological edge, all contributing towards higher market share of private sector banks .

From the medium-term perspective, we expect “corporate lenders”, whether private banks or PSU banks to outperform the industry. The stagnant advances for such lenders have started showing growth. For Q2FY19, the growth in advances for SBI is 9% compared to 4% in Q1Fy19 and -0.1% in Q2FY18. 

Similarly, for ICICI Bank, the growth in advances for Q2FY19 is 12.8% compared to 11.3% in Q1FY19 and 6.3% in Q2FY18. Apart from growth, as provision requirements have peaked and the advances growth primarily comes from AA and AAA rated companies, asset quality too has started to improve. For Federal Bank, for instance, the distribution towards AAA/AA rated corporate book stands at 71%. For most corporate lenders, fresh slippages are from within the watchlist. Axis Bank in this quarter reported lowest slippages in the last 10 quarters. The pre-provisioning profits for these lenders are increasing at a healthy average of 12%. With capex cycle improving in the government as well as private sector, we expect advances growth to continue at a healthy pace.

All these improvements in financials will demand valuation re-rating for such corporate lenders, who are still trading at half their valuations compared to retail lenders. As growth ratio between corporate lenders to retail lenders narrows down and valuations ratio picks up, we assume corporate lenders to fetch higher returns for the investors.

Prasanna Pathak
Fund Manager - Equity Taurus Asset Management Co. Ltd

What is your outlook on the banking stocks?
The corporate banking space looks interesting going ahead. The NPA cycle seems to have peaked out, the asset resolution bodes well, capex cycle is slowly gathering pace and the base for the next year is very favourable. We expect sharp earnings recovery next year on a benign base.

Will private banks continue to outperform PSU banks in the long run?
As stated above; the NPA cycle is peaking and the asset resolution and favourable base should augur well for corporate lenders even from the PSU lot. So, there will be a period in the coming few quarters where the larger PSU banks might outperform the private retail-focused lenders. However, if we look at a longer horizon, the private banks will continue to outperform.

How do you see the liquidity problems among NBFCs affecting banking sector?

The systemic liquidity is typically tight in second half of the financial year. Hence, liquidity crisis like the one we have seen recently needs to be addressed more proactively. We see uncertainty on many counts:
1) Asset quality of wholesale lenders especially in opaque and illiquid segments like real estate, where markets remain concerned.
2) Potential regulations on ALM/liquidity buffers/leverage for NBFCs/HFCs which could have structural implications for growth/profitability.
3) Potential direct or indirect support to NBFCs/HFCs from regulators/government.
4) Mutual fund flows and potential regulations on MF exposure will be the key for their appetite for and capacity to invest in NBFCs/ HFCs.
5) Interest rate trajectory

The funding situation is evolving. The loan growth, in the short term, may moderate for wholesale lenders/NBFC/HFCs. Some of the stronger banks might use this opportunity to gain some market share.

Dinesh Rohira 

"The Indian banking sector, coupled with select financial companies, have remained under volatile regime in the past one year, led by earnings halt due to higher provisioning against NPAs, high levels of slippages by corporate banks seen during Q4FY18, and the recent liquidity concerns among NBFCs triggering a sell-off across the market. These factors led to the underperformance in the banking and finance sector funds, which declined by 5-8 per cent, while the category is down by about 4.98 per cent in the last one year. However, in the last one month, these funds have seen a positive return, backed by prompt corrective action by the central bank coupled with softening of benchmark bond yield."


Conclusion
While banks in India have been on a dream run for over a decade, they have bumped into a rough patch lately. Usually the banking business is impacted by the overall economic environment, government policies, industrial growth in the economy and also the introduction of new technology.

While majority of the private banks are optimistic about their financial performance and ability to deliver sustainable double-digit growth, success will depend on how fast these banks adopt cuttingedge technology and connect with customers who are increasingly using digital platforms to do business.

Investors will have to watch closely how disruptive the new technology can be and how far is the technology expected to impact the profitability of the banks in the system. NPA problems are expected to subside in CY2019. Also the current government will infuse capital in the banking system which will help banks stabilise.

Investors should stay tuned to the banking sector as a lot of action is expected in this space in spite of the challenges it faces. The sector has rewarded investors for so long, and there is no reason to overlook the sector for investment opportunities, investors will just have to be more selective than before.

Note: Please turn over to the next page for an in-depth ranking of top PSU and Private Banks based on their fundamental parameters.

Methodology & Ranking of Banks

Ranking provides a universally accepted benchmark of performance and the credibility of ranking depends on the methods and processes that are employed. At DSIJ, it is our constant endeavour to adopt standards and methodologies that are rigorous and exactitude in approach for the financial analysis of the companies or banks, which will help our readers to make the right investment decisions.

PARAMETERS
Broadly speaking, we have sought to analyse and rank the banks based on the following parameters:



1. Capital Adequacy: The ratio signifies the stability of the bank and is used to protect depositors. Under the capital adequacy parameters, we have used two ratios to measure the capital adequacy of the bank. First is the total capital adequacy ratio as per Basel III norms and second is Tier I capital of the bank.

2. Asset Quality: Interest income remains one of the major sources of income for banks and when the borrower fails to make interest or principal payments for 90 days, the loan is considered to be a non-performing asset. This adversely impacts the financial health of the banks. For evaluating the asset quality of the bank, we have used the ratio of gross nonperforming assets (GNPAs) to gross advances and net NPAs (NNPAs) to net advances.

3. Management:
The performance of any company or bank depends on the quality of its management. To gauge the performance of management, we have analysed business per employee and profit per employee.

4. Earnings: The performance of any organisation boils down to how efficiently it uses its resourses to generate income. To measure this, we have used return on assets (ROA), return on equity (ROE) and net interest margin.

5. Liquidity:
Liquidity ratio of the bank measures the extent to which a corporation or bank has cash to cover short term liabilities. We have used credit deposit (CD) ratio and CASA ratio to determine the liquidity of the banks. n Growth: The most important criterion for determining a bank’s success is, naturally, the growth that it achieves over a period of time and also its capacity for growth in the future. For ranking of banks, we have used growth in advances, deposits and net profit.

6. Shareholder’s Return:
Shareholder remains one of the most important stakeholders of any organisation and hence the returns generated for them by the bank is important to know how the market is reacting to all the factors discussed above.  

7. Valuation:
Price to Book ratio used to check valuation status of banks. Here we have evaluated how the bank is placed as compared to the book value in the current market.

THE RANKING METHOD
After having laid out the data according to the various parameters as discussed above, we then embarked on the final step of ranking these banks. Although all the parameters and sub-parameters described above play an important role in determining bank’s performance, they differ in importance of the quantum.

We have carefully measured this requirement and, accordingly, assigned weights to each of the parameters. We have then ranked the banks and these are the major headings under which we have ranked them.












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