Indian banks are facing a higher risk of defaults from unsecured loans: UBS

Indian banks are facing a higher risk of default from unsecured loans because the share of lending to overdue borrowers rose from 12 per cent in 2018-19 (FY19) to 23 per cent in FY23, said Swiss brokerage UBS in a note.

“We expect the industry’s credit losses from unsecured loans to rise 50-200 basis points (bps) in FY25. We raise our credit cost forecasts for the India banks we cover by 5-10bps in FY25,” the note said. 

The impact is likely to be higher for non-banking financial companies (NBFCs).

The note said the share of borrowers with more than five personal loans rose from 1 per cent in 2018 to 7.7 per cent in March 2023.

Moreover, new personal loan disbursement to borrowers with weaker credit profiles exposes this segment to a potential downcycle.

The note said NBFCs and state-owned banks had a higher share of weak borrowers who had taken personal loans than large private banks did.

It said unsecured loans as a percentage of the total rose to 11.1 per cent for State Bank of India (SBI), 12.8 per cent for ICICI Bank, and 10.7 per cent for Axis Bank, but fell to 11.9 per cent for HDFC Bank.

“We believe the probability of regulators increasing the risk weight for (personal loans) is rising,” the note said.

The UBS note said though the Nifty Bank index’s valuation seemed inexpensive, there was limited scope for re-rating.

Typically, the street ups the price-to-book or price-to-earnings multiple for a stock when there are positive triggers as such strong earnings growth possibilities. This phenomenon is called re-rating.

UBS, on the other hand, sees pressure on earnings. 

“Considering our expectations of decelerating earnings growth owing to potential net interest margin (NIM) compression and an uptick in credit cost, we cut EPS by 2-5 per cent (FY25E) mainly due to increased credit costs,” the note said.

The brokerage downgraded SBI from “buy” to “sell” and Axis Bank from “buy” to “neutral”. IHDFC Bank and IndusInd Bank are its top picks. 

The note said SBI and Axis Bank’s return on assets (ROAs) was more sensitive to credit-cost changes than it was the case with their large peers. The brokerage reduced the price target of SBI from Rs 740 to Rs 530 and Axis Bank from Rs 1,150 to Rs 1,100. It also gave a “sell” rating for Kotak Mahindra Bank from Rs 2,050 to Rs 1,875.

The Nifty Bank index on Friday closed at 44,288, with a decline of 311 points, or 0.7 cent, underperforming the market.  

SBI declined 1.7 per cent and ended the session at Rs 576. Axis Bank fell 2.4 per cent and Kotak Mahindra Bank 0.6 per cent.

“Growth in personal loans is concerning because some are yet to repay their debts. The NIM of banks peaked either in the March or the June quarter. The last two quarters were some of the best for state-owned banks. All this has been priced in. From the September quarter, we will see NIMs coming down. I don’t see any positive surprises from now on,” said Ambareesh Baliga, independent equity analyst.

On a year-to-date basis, the Nifty Bank index is up 3 per cent and the Nifty PSU (public sector) Bank index has gained 17 per cent.

Banking stocks have the highest weighting in the benchmark Sensex and the Nifty.