Banking sector: Future Growth Compounded

With proactive reforms and radical legislative measures set to clean up the PSBs' NPA mess, the banking sector provides long term investment opportunity for investors. Team DSIJ analyses the growth potential of the sector and comes up with top four recommendations in the listed banking space.

The Indian banking sector has come a long way through the decade of liberalisation to the era of reforms. Grappling with issues such as growing non-performing assets, mounting bad loans and weak balance sheets and a large population devoid of access to banking services for long, the sector has witnessed a string of reforms over the last three years. Instrumental in providing a boost to the sector, reforms such as Prime Minister Jan Dhan Yojna, Insolvency and Bankruptcy Act and resolution of stressed loans, among others, have collectively strengthened the sector, resulting in a strong performance of the banking sector in the stock market and a rapid recovery on the financial front. 

The passage of the Insolvency and Bankruptcy Act in 2016 manifested as a panacea to the stressed loans issue and speeded up the legal processes. At the forefront of all the reforms was the Prime Minister Jan Dhan Yojna, the world’s biggest financial inclusion programme, which aided the sector to widen its customer base and penetrate into un-banked and under-banked sections of the society. Although major banking services are yet to find their way to the majority of the population, the PMJDY resulted in the opening of about 11.50 crore bank accounts in the country. 

Along with the government, the Reserve Bank of India, under the leadership of Raghuram Rajan, tightened its grip on stressed loans with mechanism such as strategic debt restructuring (SDR), joint lenders’ forum (JLF) and Scheme for Sustainable Structuring of Stressed Assets (S4A), among others. The establishment of Banks Board Bureau, professionalisation of the public sector banks to enhance accountability and revision of performance indicator in order to facilitate convenient capital infusion were significant boosters for the sector, among other reforms. The amendment of the Banking Regulation Act and the passing of NPA ordinance have empowered the RBI and the banks through oversight panels and independent professionals that protect the banks from interference from agencies such as CBI and CAG, thus facilitating stringent actions against the defaulters. The reforms are largely pushing the sector towards attaining higher autonomy in decision-making, greater transparency and time-bound resolution of stressed loans. 

While the reforms are expected to record significant improvement in the sector, especially the NPA issue, the Indian banks are witnessing continuous increase in their NPAs, of late. In the first quarter of FY18, the total bad loans of 38 Indian listed commercial banks had surpassed the Rs8 lakh crore-mark, recording a steep rise of over 34 per cent on a year-on-year basis. The NPA ratio in June 2017 rose to its highest level at 10.21 per cent in the past three quarters, as against 8.42 per cent in June 2016. On a quarter-to-quarter basis, the banks recorded an increase of about 16.6 per in June 2017. The public sector banks surpassed the private sector in the rise of their NPAs. The top 20 banks with the highest NPA ratio comprised of mostly public sector banks. IDBI Bank and Indian Overseas Bank recorded the highest NPA ratios of 24.11 per cent and 23.6 per cent, respectively, whereas Indian Bank recorded the lowest NPA ratio among its peers at 7.21 per cent. ICICI Bank and Axis Bank were the only private sector banks to be amongst the top 15 banks with highest NPAs. ICICI Bank and Axis Bank had posted a combined NPA share of 7.9 per cent. The public sector banks cumulatively command a much higher stressed loan ratio (12.3 per cent) than the private sector banks.

While State Bank of India has the largest share in the total NPAs at about 22.7 per cent, Yes Bank is the only bank presently with an NPA ratio of just less than one per cent. The top eight banks with the highest NPAs accounted for NPA ratio of over 15 per cent in June 2017 and top five banks including SBI, PNB, BOI, IDBI and BOB cumulatively accounted for a share of 47.5 per cent at Rs3,93,154 crore. Following the growth in the NPAs, the high requirement of provisions have also resulted in drastic decline in the profits of the banks. However, the banks are expected to rapidly recover from the plunge in their profits with the resolution of NPA issue. Although the sector is yet to reap all the benefits of various reforms rolled out to curb NPAs, the sector is riding on high hopes and the banking stocks are on a growth momentum on the bourses.

As a major part of the reform, the banking sector has witnessed a streak of consolidations recently, especially among the PSBs. Instrumental in the government’s disinvestment plan, the sector saw one of the biggest consolidations with State Bank of Bikaner and Jaipur (SBBJ), State Bank of Hyderabad (SBH), State Bank of Mysore (SBM), State Bank of Patiala (SBP) and State Bank of Travancore (SBT) and BMB, merging with the parent SBI. The consolidation was in line with the government ’s aim to create a few global banking behemoths in place of a large number of state-owned banks. With the consolidation, SBI grew its customer base to around 37 crore with a network of over 24,000 branches. 

The sector is likely to witness more consolidation among the 21 PSBs, most likely resulting in the creation of 10-12 mediumsized banks and 3-4 large banks. However, regional banks such as Andhra Bank will be exempted from consolidation , thereby creating a three-tier structure in the sector.

While the strain of stressed and bad loans and a sluggish corporate investment environment have affected the credit growth of public sector banks, the domestic private sector banks are booming with dynamic credit growth which has surpassed the credit growth of foreign banks. Outperforming the public sector banks in terms of both credit growth and deposits growth, the private sector banks are swiftly moving towards embracing global technological advancements and developments in the sector. 

While investors are heavily betting on the sector on the back of the numerous reforms, advancement in technology is also likely to play a key role in the way forward for the banking sector. With growing inclination towards digital transactions, especially after demonetisation, the advancement in technology is largely transforming the face of the banking sector in our country. The new technologies that are vying to take over the sector include regression models powered machine learning, the penetration of digital services in areas such as corporate banking and SME banking, thriving markets for Unified Payments Interface (UPI) and Aadhaar-Enabled Payment System (AEPS) payments, automated personalisation and artificial intelligence (AI) aided back-end operations. While the technological advancements will enhance transaction convenience for customers, it will largely reduce the cost for the bankers and aid the banks to capitalise on insights into customer behaviour, responses, expectations and personalisation 

At the helm of all technological developments, the revolutionary complex technology of blockchain has also found its way into the Indian banking sector. Banking majors such as ICICI Bank and South Indian Bank are incorporating blockchain technology in their operations to cut on data storage cost and increase transactional efficiency. In a remarkable development, NITI Aayog is creating ‘IndiaChain’, India’s largest blockchain network, with an aim to put an end to internet fraud, speed up contract enforcement and enhance transparency. While Indian banks are slowly but steadily taking technological leaps, the ones that are ahead in this race are likely to gain the most on the financial front and on the bourses. 

On the stock exchanges, while BSE Bankex has largely outperformed S&P BSE Sensex and NSE Nifty50, NSE PSU Bank is also not too far behind. In the past three years, BSE Bankex has provided 69.58 per cent return, as against 31.96 per cent return for Sensex and 36.49 per cent return for Nifty50. The Nifty PSU Bank index recorded a return of 35.15 per cent for the three-year period. In the three-year return, BSE Bankex has outperformed NSE PSU Bank index. However, in terms of yearly returns, NSE PSU Bank has recorded a return of 40.91 per cent, while BSE Bankex has recorded a return of 32.40 per cent on the back of the line of consolidations and reforms among the PSBs.

CONCLUSION The sector is at a crucial junction of transformation and is likely to deliver with greater vigour in the coming quarters and beyond. While the total lending in the sector has increased at a CAGR of 12.38 per cent between the period FY07 and FY17, the sector has witnessed a rise of 10.08 per cent CAGR in its total deposits during the corresponding time period . The total deposits of the sector has reached the USD 1.54 trillion-mark during FY17. The sector is expected to witness a further growth in its aggregate lending on the back of strong demand for housing and personal finance and a tremendous growth in its reach to newer markets through technology and strategic consolidations in the sector. According to the estimates by ICRA, the Indian banking sector is expected to witness a credit growth of about 8 per cent in FY2018. The total banking sector assets have already witnessed a growth across sectors at a CAGR of 7.61 per cent to USD 1.957 trillion between FY13 and FY16. Further, with the roll-out of schemes such as the affordable housing loans with Credit Linked Subsidy Scheme (CLSS) and the growing trend towards digital banking transactions, the Indian banking sector is set to grow exponentially in times to come.

South Indian Bank Limited
BSE CODE532218
Face Value Rs1
CMP Rs31.10
Market Cap 5,616.01 F F (Cr.)

South Indian Bank Limited is a major private sector bank providing retail and corporate banking, para banking activities, third-party product distribution, in addition to treasury and foreign exchange business. The bank has a network of over 800 branches, 40 extension counters and 1,290 ATMs across India. Recently, the bank has successfully executed overseas transactions using blockchain technology in partnership with a leading currency exchange house in West Asia, thus joining a niche group of banks in the global market to exchange and authenticate remittance transaction messages electronically on blockchain in real time. On the financial front, the net sales of the company increased by 5.93 per cent to Rs1536.2 crore in Q2 of FY18 as against Rs1450.18 crore in the same quarter of the previous year. The company’s PBDT increased by 54.79 per cent to Rs 460.27 crore in Q2 of FY18 on a yearly basis. The company’s net profit decreased 96.09 per cent to Rs4.32 crore in Q2FY18 as against a net profit of Rs110.52 crore in the second quarter of the previous yearOn an annual basis, the bank’s net revenue increased 5.21 per cent to Rs5847.08 crore in FY17 on a year-on-year basis. The company’s PBDT increased 38.13 per cent to Rs1214.59 crore in FY17 as against Rs879.28 crore in the previous fiscal. The net profit of the company increased by 17.77 per cent to Rs392.5 crore in FY17, as against Rs333.27 crore in the previous fiscal. On the valuation front, the bank maintained a PE ratio of 19.56x. Its return on equity (RoE) stood at 9.46 per cent. The bank has been maintaining a healthy dividend payout of 21.36 per cent. Considering the current market trend, we recommend our reader-investors to BUY the stock.

Yes Bank
BSE CODE 532648
Face Value Rs2
CMP Rs306
Market Cap F F (Cr.) 54,875.11 

Yes Bank is among India's five largest private sector banks. Incorporated in 2003, the bank has steadily built a full-service commercial banking enterprise with corporate, retail and SME banking platforms, with a comprehensive product suite. It was the first bank to offer differentiated rates on savings account following RBI's deregulation of savings account rates in October 2011. In Q2 of FY18, Yes Bank reported a net profit of Rs1,002.73 crore, up about 25 per cent from Rs801.54 crore in the same quarter last year. Net interest income (NII), or the core income a bank earns by giving loans, increased 33.49 per cent to Rs1,885.09 crore, whereas other income was up 35.43 per cent to Rs1,248.44 crore from Rs921.86 crore a year ago. The bank’s bad loan situation deteriorated as the gross non-performing assets (GNPA) grew to Rs2,720.34 crore (1.82 per cent) during the second quarter of 2017-18 from Rs916.68 crore (0.83 per cent) in the corresponding period last year. Net NPAs also rose to 1.04 per cent of assets as of September 2017-end as compared to 0.29 per cent in the comparable period of2016-17. On the valuation front, the bank maintained a PE ratio of 18.73x. The bank’s return on equity (RoE) and return on capital employed (RoCE) stood at 18.58 per cent and 73.76 per cent, respectively. The bank has been maintaining a healthy dividend payout of 17.07 per cent. Yes Bank also has good consistent profit growth of 27.77 per cent over the last 5 years. Recently, the bank announced that it is raising $400 million through two syndicated loan transactions in Taiwan and Japan. We recommend our reader-investors to BUY the stock.

Kotak Mahindra Bank
BSE CODE 500247
Face Value Rs5
CMP Rs1000
Market Cap F F (Cr.) 131398.10 

Kotak Mahindra Bank is an Indian private sector bank headquartered in Mumbai. It offers a wide range of banking products and financial services for retail customers and corporates through a variety of delivery channels and specialised subsidiaries in the areas of personal finance, investment banking, life insurance, and wealth management. The bank has a network of over 1,350 branches and more than 2150 ATMs across the country. On the financial front, Kotak Mahindra reported a 22 per cent increase in standalone net profit at Rs994 crore in Q2 of FY18 as against Rs813 crore in the same period last year. Its net interest income increased 16 per cent year-on-year at Rs2,313 crore. Other income increased 15 per cent to Rs954 crore. The bank’s net interest margin (NIM) declined a bit to 4.33 per cent in the reporting quarter from 4.47 per cent in the year-ago period. The bank's total deposits increased by 17 per cent to Rs1,65,671 crore, out of which the proportion of CASA deposits improved to 47.8 per cent from 39 per cent in Q2FY17.During the quarter, total advances were up 21 per cent to Rs1,52,574 crore. Also, the gross non-performing assets as a percentage of gross advances improved a tad to 2.47 per cent, as against 2.49 per cent in the same period last year. On the valuation front, the bank maintained a PE ratio of 39.12x. The bank’s return on equity (RoE) and return on capital employed (RoCE) stood at 13.73 per cent and 34.85 per cent, respectively. The bank has good consistent profit growth of 21.89 per cent over the last five years. We recommend our reader-investors to BUY the stock.

Punjab National Bank
BSE CODE 532461
Face Value Rs2
CMP Rs172
Market Cap F F (Cr.) 13,912.44 

Punjab National Bank (PNB) is a state-owned multinational banking and financial services company. The core strengths of the bank is the brand image with rich 122 years of existence, more than 10 crore customers, wide CASA base, consistently growing operating profit, increasing small ticket business through leveraging RUSU (Rural & Semi Urban) customer base, stable asset quality and increased pace of digitalisation. PNB has a network of 6941 domestic branches and 9753 ATMs as on September 30, 2017. As a part of its consolidation plan, PNB has planned to close down, merge or relocate about 200-300 of its lossmaking branches over the next 12 months. Recently, PNB also announced that it has received shareholders' approval for raising Rs5,000 crore either through Qualified Institutional Placement (QIP) or rights issue. On the financial front, PNB reported a 2 per cent rise in its net profit at Rs560.58 crore for the quarter ended September 30, 2017 as against Rs549.36 crore for the same period last year. The net interest income of the bank increased by 3.49 per cent on year-on-year basis to Rs4015.18 crore, as against Rs3879.85 crore in the correspondingquarter last year. The asset quality of the bank improved marginally during the quarter gone by. The percentage of gross NPAs stood at 13.31 per cent in Q2FY18 as compared to 13.66 per cent in Q1FY18 and the percentage of net NPAs also declined to 8.44 per cent from 8.67 per cent during the same period. On the valuation front, the bank maintained PE ratio of 26.84x. The bank’s return on equity (RoE) and return on capital employed (RoCE) stood at 3.59 per cent and 28.31 per cent, respectively. The stock is trading at 0.94 times its book value. Also, the promoter's stake has increased. We recommend our reader-investors to BUY the stock.

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:n 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. n 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 adverselyimpacts 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. n 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. n 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. n 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. n 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. n 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 on the basis of ownership such as public, private, old and new private sector banks. These are the major headings under which we have ranked the banks.