Public sector banks ready to end private banks’ dominance? Expect valuation re-rating; check stocks to buy

With the recovery in loan growth, steady deposit growth and improvement in asset quality, the previous financial year has proven to be a watershed year for public sector banks.

Bank stocks
Public sector banks' aggregate loan growth in fiscal year 2022 improved to 8.8% — the highest since the financial year ending March 2014. (IMAGE: Pexels)

With the recovery in loan growth, steady deposit growth and improvement in asset quality, the previous financial year has proven to be a watershed year for public sector banks (PSB), according to analysts at Bank of America Securities (BofA). With healthy asset quality and strong provision coverage ratios, analysts believe valuation of PSBs could witness re-rating on continued improvements in growth-RoE profile. On the other hand, the brokerage firm believes the improvement in state-owned lenders could result in the end of easy market share gains for private banks.

“Financial year 2022 was arguably a watershed year for PSBs – after a long asset quality cycle, their balance sheets are now healthy enough to start growing again,” BofA said in a note. According to analysts, this will drive system loan growth to improve sustainably to trend 12-13% levels from the current 10%.

What have PSBs done?

Public sector banks’ aggregate loan growth in fiscal year 2022 improved to 8.8% — the highest since the financial year ending March 2014. Meanwhile, private sector banks saw 16%  growth. “More importantly, growth across PSBs was more broad-based across segments,” BofA said. In terms of deposits, growth was 8.4% on-year during the period under review and 5.2% sequential growth was recorded in the fourth quarter. 

In terms of net interest margin, helped by improving loan growth and asset quality, PSBs saw continued NIM improvements, taking them to decade highs. On the NPA front, coverage now stands at 75%, which is better than private banks. However, return ratios still remain sub-par. “Despite lower capital levels, PSB ROEs are still sub-par and below cost of equity. The key drag is from lower NIMs and higher credit costs – likely to improve from this fiscal year as both improve,” BofA said.

Time for private banks to worry

For private banks, the real threat is on the liabilities front, according to BofA. “Tighter liquidity conditions plus a more aggressive PSB sector could meaningfully impact access and cost of funding for private banks — a big tailwind over the past 5-6 years,” they added. Analysts said they are less worried on the asset side, however, the margin pressure on corporate and mortgage book will likely increase further.

Stocks to buy

Bank of America has reiterated their bullish views on State Bank of India (SBI) and Bank of Baroda (BoB). For the former, BofA has set a price objective of Rs 600 per share, translating to an upside of 30% from Wednesday’s opening price of Rs 461 per share. 

Bank of Baroda has a price objective of Rs 130 per share, up from Rs 96 per share on opening today. This translates to an upside of 35%.

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