CLSA thinks pvt banks may outperform PSBs ahead; check reasons, top picks

CLSA expects private sector banks, which have been stock market laggards over the past few months, to give better returns ahead, given a good business outlook and inexpensive valuations

CLSA on Indian Banks: Indian banks are currently enjoying their strongest balance sheets in over a decade, marked by considerable improvements in asset quality, and provision buffers, international brokerage CLSA said in a recent note.

With sector profitability quadrupling over the past decade, and return on Equity (RoE) at its highest level since FY11, standing at 15 per cent on average for the sector, CLSA believes Indian banks are well placed after "a rollercoaster decade”.

Specifically, it expects private sector banks, which have been stock market laggards over the past few months, to give better returns ahead, given a good business outlook and inexpensive valuations (10-15x PE versus the Nifty50 at 18x).

Individually, the brokerage prefers ICICI Bank and IndusInd Bank as its top picks.

Here are the key factors which has kept CLSA bullish on India banks:

Cleaner balance sheets, record profits
 

Banks, according to CLSA, have much stronger balance sheets today as compared to five or ten years ago. Besides, not only are they well capitalised, they also have the lowest net non-performing loan (NPL)/net worth in more than a decade.

From a peak of 44 per cent in FY18, the net NPL/net worth ratio declined to only 6 per cent in FY23 (even lower in FY24, in our view) driven by a lower GNPL ratio, higher provision buffers, and higher capital adequacy.

On the profitability front, standalone profits have more than quadrupled from Rs 80,000 crore to Rs 3.4 trillion in the past ten years, implying a 16 per cent compound annual growth rate (CAGR).

"We accept that FY24 profit after tax (PAT) was aided by corporate recoveries and low credit costs, but we believe the sector will deliver low double-digit PAT CAGR over the medium term," CLSA said.

Capital adequacy
 

Both PSU and private sector banks have bolstered their capital positions in recent years, with Tier-1 ratios improving to 13 per cent and 17 per cent respectively by FY23.

Despite a slight decline in FY24 due to regulatory changes, CLSA believes banks remain well-capitalised, supporting sustained profitability and growth prospects.

Loan growth
 

Banking sector loan growth has accelerated to 15 per cent in recent years, up from an average of 10 per cent over the previous decade. This growth spans all segments, potentially fuelled by a shift from corporate bonds.

“While we expect a degree of normalisation in unsecured loan growth from over 20 per cent to mid-to-high teens, we estimate overall loan growth at 14-15 per cent over the next two years,” CLSA said in a note.

Private sector banks are anticipated to continue gaining market share, leveraging their competitive edge in current account deposits and reduced non-deposit borrowings.

Deposit growth outlook

While recent years saw a temporary slowdown in deposit growth, attributed to lower reserve money expansion, analysts at CLSA foresee a rebound driven by improved macroeconomic conditions.

"Specifically, the 7-8 ppt difference in the current account (CA) deposit ratio would led to 30 bps savings in the cost of deposits for private sector banks. Hence, while private sector banks offer a higher interest rate on term deposits and have a higher share of wholesale deposits, the overall cost of deposits is competitive vis-à-vis PSU Banks," CLSA said in its report.

Sector performance and valuations
 

Over the last five years, PSU Banks have outperformed private sector banks by approximately 100 percentage points, reflecting a strong turnaround from a previously low base.

Despite being stock market laggards, private sector banks are expected to yield better returns going forward due to favourable business prospects and attractive valuations (10-15 times Price-to-Earnings ratio compared to Nifty50's 18 times), analysts said.

Key risks for India banks
 

While the banking sector anticipates continued growth momentum, analysts at CLSA believe risks such as potential sharp repo rate cuts could impact Net Interest Margins (NIMs) negatively in the near-term.