Private banks may lose premium edge

Restrictions on new branches, fee-based businesses could hit profitability, valuation: CLSA report

The recent expose of alleged violation of laws and money-laundering laws at three private sector banks may hit the premium that banks in the segment enjoyed over their public sector counterparts.

The premium that these banks enjoyed on account of factors including perceived better governance may begin to narrow, according to a report by CLSA Asia-Pacific Markets.

“Valuations of private banks are currently at an 86% premium to PSU banks and this event may lead to some narrowing of premium,” said the report dated 18th March and authored by Aashish Agarwal, Prakhar Sharma and Akshat Agarwal.

The report cited possible regulatory restrictions on new branches or fee-based businesses which could impact profitability and valuation of these banks.

A former banking industry official with three decades of experience suggested that a definite impact could be felt if there are strong indications of misconduct at the banks.

“The RBI could pass a lot of strictures which will make it difficult for business development. The focus of the business may shift from growth to an in-house clean-up. This could lead to a corresponding fall in growth,” he said, preferring anonymity due to the sensitive nature of the issue.

He added that any effect on growth would depend on the findings of the enquiry but in the longer run the gap between private and public banks has to narrow.

“One cannot have a situation where public sector banks trade at less than book value and private banks trade at twice their book value,” he said.

Online media portal Cobrapost published an investigation which revealed violations of income tax and money laundering regulations including by routing illicit money through insurance investments, at a series of branches of HDFC Bank, ICICI Bank and Axis Bank.

The banks have launched their own enquiry into the matter. The RBI and the government are also looking into the same.

The CLSA report noted that RBI took a tough stance in 2005-06, when seven banks were found in violation of norms for opening bank accounts and financing of initial public offerings. It imposed penalties and branch growth slowed at the accused banks.

“Branch licensing is lot more liberal now, but RBI and other regulators can still make regulations tougher and that can impact growth and profitability,” said the report.

However, fund managers aren’t rushing to PSUs yet.

Arun Khurana, Fund Manager of UTI Banking Sector Fund, and UTI Service Sector Fund stated that public sector banks are unlikely to steal the limelight from their private sector banks following the expose.

“There are questions over NPAs(non-performing assets or bad loans) as well as the profitability of public sector banks. It doesn’t seem likely that there will be a change in the premium given to private sector banks,” he said.

Saibal Ghosh the Chief Investment Officer of Aegon Religare Life Insurance Company also saw little room for a re-rating.

“The return on assets (ROA- a measure of how efficiently the company uses its assets) of private banks is at around 1.5 percent while that for PSU banks is at 0.7-0.8 percent. I don’t think it will narrow,” he said.

The S&P BSE Bankex, an index which tracks the performance of banking stocks, is down 0.29% since the sting.  

Axis Bank is down 1.6% since the expose, closing at Rs.1324.85 on Monday. ICICI Bank is down 3.2%, closing at Rs.1051.1. HDFC Bank is up 1.3%, closing at Rs.643.55.