Banks The Road Ahead

Amidst the varied sectoral performances in Q2FY24, the Indian banking sector emerged as a beacon of resilience. Almost every bank not only registered double-digit growth in both top-line and bottom-line figures but also yielded exceptional returns for investors. However, acknowledging the adage that returns are seldom solitary, the banking industry is not without potential risk factors. Mandar Wagh offers an insightful exploration of the financial performances of banks and returns, delving into the factors driving their success and examining both future opportunities and potential threats 

The Q2FY24 performance of Indian Inc. presented a mixed picture, even though it leaned towards positive results. Various sectors reported diverse outcomes in both top-line and bottom-line performances with companies navigating through distinct headwinds and tailwinds specific to their respective sectors. Leading IT companies such as Infosys, TCS, HCL Technologies and Wipro have reported restrained financial results, attributing them to the impact of persistent macroeconomic uncertainties and reduced expenditures in key markets. Consequently, the guidance and commentary have maintained a pessimistic stance. [EasyDNNnews:PaidContentStart]

The metals and mining industry displayed a varied performance with lower coking coal costs attempting to offset the drop in steel prices, thereby enabling companies to boost their EBITDA. The power sector saw significant growth in most companies, fuelled by heightened power consumption in the country. The optimistic outlook for the industry is further supported by the upcoming festival season and improvements in economic activity. Within the FMCG sector, a majority of companies disclosed notable growth in profit margins, attributed to the relief in raw material prices. However, they encountered pressure on volume growth. 

Real estate developers are witnessing unprecedented presales and this positive momentum is anticipated to persist in the upcoming quarter, boosted by the launch of new projects that are poised to amplify presale figures. The latest quarter saw new property launches surpassing the one lakh milestone across the top seven cities. Considering the automobile sector, despite the robust growth in the sales of SUVs, three-wheelers and commercial vehicles, the overall volumes for the quarter did not present an overwhelmingly positive picture. This was impacted by a notable decline in sales for two-wheelers, passenger cars and tractors, affecting the sector’s overall performance.
 

Banking Sector

Amidst the fluctuations of the quarter, the Indian banking sector displayed remarkable resilience. Almost all banks not only reported double-digit year-on-year (YoY) growth in both top-line and bottom-line figures but also witnessed a remarkable surge in their share prices, capturing significant attention from investors. Indian banks have also outperformed global peers on various financial parameters, driven by strong profitability, higher growth expectations and prudent risk management, as per a report by McKinsey and Company. 

Indian banks enjoyed higher price-to-book value as they have posted healthy credit growth of 10-11 per cent over the last decade with higher ROA (return on assets) than their global peers, resulting in a valuation premium. The report also highlights that Indian banks’ profitability is higher than the pre-pandemic levels with resilient NIMs (net interest margins) and declining credit costs contributing to healthy margins. The captivating performance of the banking sector has prompted the need to delve into the growth drivers behind this success, as well as to explore the road ahead with potential opportunities and risks.
 

Q2FY24 Financial Performance 

Interest Income - Interest income stands as a pivotal element within a bank’s total revenue, stemming from the interest levied on loans extended to customers, the interest earned from fixed income securities, and other interest-bearing financial instruments within the bank’s portfolio. Serving as a significant contributor to a bank’s profitability, it also acts as a crucial indicator of the lending and investment activities of the bank. The majority of banks achieved impressive interest income figures, attributed to the strong expansion of their loan portfolios, especially in higher-yielding assets like personal loans, mortgages and commercial loans. Additionally, the banks capitalised on higher interest rates, leading to an increased net interest margin. 

Furthermore, successful efforts to improve the asset quality of non-performing assets contributed to this positive financial outcome. For example, State Bank of India reported the highest interest income, amounting to ₹ 101,378.80 crore, experiencing a year-on-year growth of 26.95 per cent. In terms of the highest year-on-year growth, HDFC Bank emerged as the top performer – achieving an exceptional 75 per cent growth with the total interest earned reaching ₹ 67,698.39 crore. The aggregate interest income for the sector witnessed a significant surge of 29 per cent during Q2FY24 compared to Q2FY23. It is worth mentioning that not a single bank has reported a decline in interest income compared to the corresponding quarter of the previous year. 

Other Income - Other income for banks encompasses revenue generated from sources beyond the conventional interest earned on loans and investments. This category includes diverse non-interest revenue streams that significantly contribute to a bank’s total income. Common components of other income for banks comprise fee income, commission income, revenue from wealth management and advisory services, foreign exchange gains, asset management fees, and more. The diversification of income sources through other income plays a pivotal role in helping banks mitigate risks associated with fluctuations in interest rates and economic downturns, thereby contributing to overall financial stability. 

In Q2FY24, State Bank of India and HDFC Bank disclosed the most substantial other incomes, totalling ₹ 10,790.63 crore and ₹ 10,707.84 crore, respectively. Meanwhile, CSB Bank showcased an exceptional 230 per cent year-on-year growth in other income, primarily attributed to lease or rental income. Bank of Baroda, Dhanlaxmi Bank and Suryoday Small Finance Bank also posted remarkable year-on-year growth rates, each exceeding 100 per cent. Notably, the sector as a whole experienced a significant 34 per cent surge in aggregate other income during Q2FY24 as compared to Q2FY23. 

Net Interest Income - Net interest income (NII) stands as a crucial financial metric for banks, embodying the variance between the interest earned on interest-earning assets such as loans and investments and the interest paid on interest-bearing liabilities such as deposits and borrowings. In more simple terms, NII signifies the income derived by a bank from its core lending and investment activities after deducting the cost of funds. A positive NII denotes that the bank is garnering more revenue from its interest-earning assets than it is disbursing on its interest-bearing liabilities. Widely acknowledged as an indicator of a bank’s core profitability, NII directs attention to the interest-centric activities constituting the primary revenue source for most banks. 

Banks meticulously monitor NII to evaluate the efficacy of their interest rate risk management strategies and identify avenues for enhancing their interest rate spread. As anticipated, the State Bank of India emerged as the frontrunner, reporting the highest net interest income of ₹ 39,499.96 crore. This was attributed to the highest interest earned during Q2FY24 compared to other industry leaders. Fino Payments Bank earned accolades from analysts and investors by achieving an impressive 82 per cent year-on-year growth in net interest income, highlighting its noteworthy performance in core lending and investment activities. 

Net Profit - Net profit for banks is an important financial metric representing the remaining amount after deducting all expenses, encompassing interest, taxes and operating costs from the total revenue generated. This metric serves as a crucial indicator of a bank’s overall financial health and performance. Understanding a bank’s net profit is essential for evaluating its financial viability, stability and the efficacy of its business operations. Additionally, net profit contributes significantly to a bank’s capital adequacy, empowering it to meet regulatory requirements and pursue growth opportunities. The net profit margin, expressed as net profit as a percentage of total revenue, is frequently utilised to gauge a bank’s efficiency and management effectiveness. 

The consistent presence of positive net profits fosters increased confidence among investors and stakeholders in a bank’s capabilities. HDFC Bank achieved an impressive 50 per cent year-on-year growth in its net profit, reaching ₹ 15,976.11 crore, marking the highest net profit recorded by any bank in Q2FY24. Punjab National Bank, Suryoday Small Finance Bank and Bandhan Bank experienced outstanding growth rates of 327 per cent, 266 per cent and 244 per cent, respectively. Conversely, Punjab and Sind Bank, UCO Bank and Karnataka Bank were the only banks that reported a year-on-year decline in net profit. 

Returns - India’s robust economic conditions, outperforming other leading economies, coupled with the strong financial performance of banks in both the public and private sectors in recent quarters and the government’s emphasis on digital initiatives have collectively bolstered optimism within the banking sector. Consequently, Indian benchmark indices yielded modest returns of around 5-6 per cent over the past year while numerous banking stocks have significantly enhanced the wealth of investors. Interestingly, Nifty Private as well as Nifty PSU Bank indices have outperformed Nifty 50 in the last one year.

The Jammu and Kashmir Bank Ltd. emerged as the top performer among all the other banks in terms of returns. The Small-Cap bank delivered an outstanding 91 per cent and 165 per cent returns year-to-date (YTD) and over the last one year, respectively. UCO Bank and Punjab and Sind Bank, despite more than doubling the wealth of investors over the last year, experienced a notable decline in recent periods attributed to lacklustre results and a decrease in profitability. It is evident that all the constituents of the BSE Bankex significantly underperformed in comparison to leading gainers. Notably, State Bank of India, Kotak Mahindra Bank and HDFC Bank yielded negative returns over both the YTD and one-year periods. Surprisingly, investors displayed significant attraction toward Mid-Cap and small-cap banks, as well as small finance banks. 

Growth Drivers - During a period where inflationary pressures gripped the global economy, a significant number of central banks globally adopted aggressive measures to counteract inflation, leading to multiple rounds of interest rate hikes. The Reserve Bank of India (RBI), with its primary focus on inflation control in policy rate formulation, reacted by implementing measures such as raising the repo rate. In a specific instance, the RBI increased the repo rate to 6.5 per cent. 

However, in a recent development, for the fourth consecutive time the RBI chose to maintain the status quo, keeping the policy repo rate unchanged at 6.5 per cent. 

In a strategic move, banks leveraged the upswing in interest rates, responding to the heightened repo rate by increasing the interest rates on diverse loan portfolios, encompassing home loans, personal loans and car loans. Skilfully aligning their lending rates to outpace adjustments in deposit rates, banks orchestrated an expansion of the net interest margin (NIM). For individuals with existing loans linked to variable interest rates, such as adjustable-rate mortgages or floating-rate personal loans, the repercussion of an augmented repo rate materialised in elevated EMIs. This shift in borrowing costs translated into a substantial boost in the bank’s interest income. In a noteworthy turnaround from the challenges faced during the pandemic, banks experienced a robust recovery in loan growth, indicating resurgence in demand conditions and a heightened interest from banks in catering to retail borrowers. The fiscal period ending on March 31, 2023 witnessed a notable uptick, with bank credit registering an impressive 15 per cent growth, primarily propelled by the retail sector. 

In response to robust demand from various sectors, banks have effectively diversified their loan portfolios, strategically distributing lending activities across a spectrum of industries to mitigate concentration risk. Concurrently, the integration of advanced technologies and analytics, encompassing artificial intelligence (AI) and machine learning (ML), has proven instrumental in enhancing risk assessment and management. The integration of these technological advancements has empowered banks to achieve more precise predictions of potential risks and optimise credit decisions. 

Consequently, these innovations have played a crucial role in helping banks enhance asset quality and reduce their non-performing assets (NPAs). These factors altogether have collectively elevated the profitability of banks. A robust net profit, contributing to a bank’s capital adequacy, is pivotal. The retention and addition of profits to a bank’s capital base effectively fortify its financial foundation. As a result, banks have adeptly sustained a healthy capital adequacy ratio (CAR), showcasing their capacity to absorb potential losses and fulfil regulatory capital requirements effectively. 

Technical View

Bank Nifty retested and successfully closed above the neckline of the double-top pattern. It decisively surpassed the 38.2 per cent retracement level of the previous downtrend. However, caution is warranted as the index still remains below the prior swing high and the 50-day moving average (DMA). Additionally, the index is yet to breach the rising trendline traced from the lows of June 2022. The recent three-week period saw the index break both the rising wedge pattern and the double top pattern. It also tested the trendline support originating from the lows of March 2020. Notably, the 10 and 20-week averages at 44,172-44,488 constitute a formidable and immediate resistance zone. The 50 per cent retracement level of the preceding downtrend aligns closely at 44,208. 

Several resistance points on the upside need to be overcome for the index to test its previous high in the upcoming 2-3 months. Conversely, maintaining a positive bias requires safeguarding the prior week's low, with the critical support level at 43,600. A decisive close below this level, coupled with higher volume, could reignite the downtrend. 

A potential disaster for the index looms if it drops below the double top's neckline at 43,633. The immediate target, as per the pattern, is 39,184, aligning closely with the previous major low. This target could materialize in less than four months. Both the PSU and Private sector bank indices exhibit lower lows and a rising wedge pattern, mirroring the Bank Nifty's trend. In summary, the index stands at a critical juncture. While the short-term outlook appears somewhat positive, caution prevails for the medium term, particularly if the index declines below 43,663, which could pave the way for much lower levels.
 

Risk Factors

RBI Raises Red Flag Concerning Unsecured Retail Loan Growth - The corona virus-related pandemic brought the world to a temporary standstill in 2020. 

Nevertheless, it catalysed remarkable growth in small-ticket loans, personal loans and consumer durables loans. These unsecured retail loans witnessed substantial growth, indicating a noteworthy demand for consumption financing among millennials and members of Gen Z. The expansion of retail credit was propelled by unsecured credit portfolios and smallticket loans. Despite the growth in credit card lending, there has been an increase in payment defaults on credit cards. Notably, serious delinquency rates for both credit cards and consumer durables experienced a significant rise. 

Despite mounting concerns over the rapid expansion of retail loans, the State Bank of India recorded a notable year-on-year growth of over 15 per cent in its retail loan portfolio during the second quarter. Similarly, Bank of Baroda experienced a parallel surge, with its retail loan portfolio expanding by 22 per cent, outpacing the growth in its domestic corporate loan portfolio, which stood at 16.5 per cent. Highlighting the substantial growth in specific segments of personal loans, RB) Governor Shaktikanta Das emphasised the close monitoring of these loans for potential signs of emerging stress. The RBI has issued a cautionary note, raising a red flag and advising banks to reinforce their risk management systems. 

Indian Rupee Hits All-Time Low as Depreciation Continues - Despite expectations of a strengthened position due to the decline in crude prices, the Indian rupee reached a new historic low against the US dollar. Falling below the existing low of ₹ 83.30 against the dollar, the Indian currency touched an unprecedented level of ₹ 83.36 per dollar. The appreciation of the US dollar presents multiple risks for Indian banks. Those with exposure to foreign currencydenominated assets or liabilities may encounter valuation losses or heightened debt burdens if they have borrowed in US dollars. Additionally, banks that have secured funds through external commercial borrowings (ECBs) or possess foreign currency liabilities may experience elevated repayment challenges. For clients or borrowers of Indian banks involved in import-dependent businesses, their ability to repay may be impacted, potentially resulting in non-performing assets. 

Other Risks - The RBI governor recently responded to a query about the duration of elevated interest rates, stating, “Interest rates will remain high at the moment. How long, only time will tell.” In light of banks strategically capitalising on higher interest rates, those with substantial exposure to fixedrate loans might encounter challenges as interest rates continue to rise. Global economic conditions, including geopolitical tensions and trade uncertainties, can impact the performance of Indian banks, especially those with international exposures. 

Conclusion

The Indian banking sector has prioritised expanding its outreach through initiatives such as the Pradhan Mantri Jan Dhan Yojana and the introduction of post payment banks. These strategic schemes, combined with substantial reforms in the banking sector such as the promotion of digital payments, the emergence of neo-banking, the growth of Indian NBFCs and the influence of financial technology, have played a crucial role in significantly advancing financial inclusion in India. The robust economic outlook of the country, coupled with the impressive financial performances of Indian banks, has attracted foreign investors to domestic banking stocks. This optimistic sentiment is evident in substantial rallies witnessed in domestic banking stocks, delighting investors with stellar returns. 

However, recognising the dual nature of rewards and risks, the banking sector confronts challenges, primarily stemming from the significant growth in unsecured retail lending, carrying the potential for emerging stress. In response to this concern, the RBI is actively taking measures to caution banks and urging them to implement remedial actions promptly. Certainly, the banking industry faces concentration risks, liquidity risks and market risks. Nevertheless, these challenges can be successfully mitigated through proactive diversification, enhancing operational efficiency and implementing robust risk management strategies. By identifying potential risks in advance and executing effective strategies, the Indian banking industry can position itself for sustained and outstanding growth in the future.

Click here to download the list of Roll of Honour: Banking Awards 2023

Click here to download the list of Q2FY24_Financial Performance Banking sector 

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