1India’s Banking Sector: Ready for take-off

Summary

We believe that the Indian banking sector is in its last leg of

provisioning for large Non-Performing Assets (peak GNPA%

of 13% now at 11%) and is going through its ‘moment of

renaissance’. During this cycle, the major differentiator of

outperformance between banks was their asset quality. Banks

with high exposure to certain stressed sectors bore the brunt

of the macro-economic slowdown, over leverage and systemic

ever-greening resulting in substantial NPAs in the large and

mid-corporate segment. Post the asset quality review by RBI

(concurrent AQR in 2016); banks seemed to have recognized

the majority of the stressed accounts, for which they have made

provisions over the last few years. We believe the NPA cycle has

peaked out and we expect lower incremental slippages (peak of

5%) and credit costs (peak of 3.5%), leading to normalization of

profitability and improving return on assets and return on equity

in the medium to long term. Apart from asset quality turnaround,

the key themes taking the centre stage for investment analysis

of Indian banks would be (a) solid liability franchise, (b) strong

cross-selling capabilities and (c) preparedness to tackle

digital disruption.

In redemption mode:

Asset Quality showing improving trends

Over the years, a huge stock of stressed assets was created

and piled up in the banking system for various reasons without

recognition, culminating in provisioning for such activities.

Problems were further magnified by management changes (with

some still pending) at quite a few banks.

In order to address this once and for all, RBI carried out an asset

quality review (AQR) of bank’s loan books (FY16). This exercise

led to the recognition of NPAs which had to be followed up

by provisions, downsizing the sector’s profitability and capital

requirements.

We remain positive on the outlook on slippages and the direction

of NPAs in the coming period as early warning indicators are

stable and there is a noticeable increase in the pace of resolution

of stressed cases referred to NCLT (National Company Law

Tribunal is a quasi-judicial body) under the Insolvency and

Bankruptcy Code.

MIRAE ASSET LENS April 2019

India’s Banking Sector: Moment of Renaissance

Mirae Asset Global Investments (India)

Harshad Borawake, Head of Equity Research

2India’s Banking Sector: Ready for take-off

Now, for the first time, since FY15, stress in the Indian banking

system (gross NPL + standard restructured loans) has declined

from 12.5% of its loan books in FY18 to 11.3%.

Hence, after 5 years of subdued profitability, led by asset quality

issues, coupled with growth slowdown and high competitiveness,

we believe that the Indian banking sector is set to redeem itself

in FY20. As credit costs normalize, banks which got hit due to

high NPAs and were de-rated will see RoEs improve and likely see

better market valuations.

15.6%

14.8%

4.0% 3.8%

11.6%

10.8%

3.6

5.9

4.1

6.2

4.6

6.9

7.6

5.8

9.6

4.8

11.6

2.7

10.8

1.9

(%)

12

15

9

6

3

0FY13 FY14 FY15 FY16 FY17 FY18 1HFY19

GNPA Trend in Indian Banks (% of Loan Book)

Source: RBI (2019)

Gross NPLs Other Impaired

(%)

16

18

12

14

10

8

6

4

0Public Sector Banks Private Banks Scheduled Commercial Banks

Bank Category-Wise Gross NPA (% of Loan Book)

Source: RBI (2019)

FY13 FY14 FY15 FY16 FY17 FY18 1HFY19

3India’s Banking Sector: Ready for take-off

Next Cycle:

Liabilities Side Prudence will Drive Performance

With the strengths and weaknesses of banks’ assets fairly

reflected in valuations, the focus should shift to liabilities (higher

share of low cost deposits). The issue has recently come to the

forefront with deposit growth lagging asset growth and low cost

Current Account Savings Account growth lagging further more.

Systemic credit growth has recovered to a five-year-high of

~14%, while deposit growth remains modest at 10% and could

be partly due to the falling household savings rate. Household

savings have fallen to a two-decade low to 17.2% of GDP from

25.2% of GDP in FY10.

This has led to higher Loan-to-Deposit (LDR) ratio, more so

for private banks where growth continues to remain strong.

And without support from the deposit growth, growth could

be curtailed. In the coming years, we believe banks that have

the strong ability to garner low cost deposits will be in an

advantageous position. Some of the required traits would be

scale (4,000+ branches), customer recall and cross sell ratio

(leading to stickiness of customer).

Indian Household Savings Have Fallen to a Two-Decade Low

Source: RBI, Spark (2019)

HH Financial savings (% of GDP) HH Physical savings (% of GDP)

25

30

20

15

10

5

0

FY90

FY91

FY99

FY10

FY92

FY00

FY11

FY93

FY01

FY12

FY94

FY02

FY13

FY95

FY03

FY14

FY96

FY07

FY04

FY15

FY97

FY08

FY05

FY16

FY98

FY09

FY06

FY17

FY18

8.4

12.0

6.6

10.68.1

Total 15.7

Total 25.2

Total 17.213.2

4India’s Banking Sector: Ready for take-off

Higher LDRs Could Limit Credit Growth

Source: RBI (2019)

-11%

12%

-8%

8%

-5%

8%

-5%

9%

Loan Deposits CASA Deposits SA Deposits

State-Owned Banks Lost Loan Market Share Much More than Deposit Market Share

Source: RBI, Bernstein (2019)

State-owned banks (ex-SBI) New Private Sector Banks

Private Srctor Banks Public Srctor Banks All Banks

(%)

90

100

80

70

60

50FY07 FY08 FY09 FY10 FY11 FY12 FY15FY13 FY16FY14 FY17 FY18

(%)

25

20

15

10

5

0Mar 14 Mar 15 Mar 16 Mar 18Mar 17 Mar 19Sep 14 Sep 15 Sep 16 Sep 18Sep 17

13%

9%

Deposit growth (YoY%) Loan growth (YoY%)

Loan Growth Ahead of Deposit Growth for the Banking System

74%

88%

69%

Source: Blooomberg (2019)

5India’s Banking Sector: Ready for take-off8.413.38.8

Digitization:

Preparedness is a Must and Execution will be

the Key Differentiator

So far the Indian banking sector has remained largely unscathed

from the new age fintech movement. However, in order to

thrive in the new digital economy, banks will have to adequately

invest in technologies to gain or retain an edge in acquiring

and maintaining customers. We believe private banks have

an opportunity to meaningfully increase their customer base,

customer wallet share and also their profitability, represented

by large payments opportunity, low cost customer acquisition,

cross-sell opportunity - Broking, MF distribution, lead generation

for other NBFCs, floating own NBFCs etc.

The Indian ecosystem (Unified Payment Interface, leap in financial

inclusion, mobile penetration) is uniquely positioned to help banks

capture this opportunity – however, execution will be the key

differentiator.

India Bankable Population Pyramid (FY20E)

Source: BofA Merrill Lynch Global Research (2019)

Wealthy

50-70 mn

Affluent - high

200-280 mn

Affluent - medium

350-400 mn

Economically weak

650-800 mn

Bankable

Customer Base

450-500 mn adults

Internet users

500 mn

Debit cards

775 mnJanDHAN

337 mnPayTM

300 mn

PayTM(Active)

100 mn

Credit cards

35 mn

Facebook

270 mnYoutube

260 mnWhatsapp

200 mn

6India’s Banking Sector: Ready for take-off

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