scorecardresearch5 structural changes that may result in contraction of valuation multiples for banking sector

5 structural changes that may result in contraction of valuation multiples for banking sector

Updated: 04 Apr 2022, 05:31 PM IST
TL;DR.

  • Last 22 years have been a remarkable phase for the banking sector – credit base grew from less than 10 lakh crore in 2000 to over 117 lakh crore now!

NBFCs are outperforming the banking industry in terms of lending growth.

NBFCs are outperforming the banking industry in terms of lending growth.

The evolution of the banking sector in both the Indian economy and the stock market is pretty impressive. The banking sector along with other service sectors like telecom, retail, etc., enabled the Indian economy to transform itself to emerge primarily as a service economy in terms of contribution to the overall GDP.

In the stock market also, the banking sector emerged as the dominant sector with over 25 percent weight being assigned to the banking sector alone in Nifty.

The last 22 years have been a remarkable phase for the banking sector – the credit base grew from less than 10 lakh crore in 2000 to over 117 lakh crore now!

This sweeping structural change in the Indian economy with the predominance of the banking industry led to major structural changes in the construction of benchmark equity indices –the banking and financial sector’s weight in Nifty grew to around 36 percent with the banking sector alone accounting for around 25 percent weight.

However, the five key structural changes happening in the banking sector is likely to lead to reducing the dominance of the banking weights in the benchmark indices and also result in a significant contraction in the valuation multiples of listed banking stocks in the next couple of years.

Shrinking credit growth: The banking credit growth rate has vertically shifted downwards and in fact, NBFCs are outperforming the banking industry in terms of lending growth. 

While the credit base of banks is growing around 8 percent year-on-year (YoY) now, the same for NBFCs are expected to grow by 14 percent in FY2022. Banking credit used to grow 23 percent YoY for about two decades and then fell to around 18 percent for some years, and then declined to around 13 percent before settling in single digits a few years ago.

New players are coming: Many small finance banks have entered the industry. Till recently, the banking sector was classified in terms of 4 segments viz., old private sector banks, new private sector banks, SBI and Associates, and public sector banks. 

Now there is a new category of banks entering the sector and consolidating themselves – it is the segment of small (micro) finance companies converting themselves into banks. There are several such finance companies like Bandhan Bank, AU Small Finance Bank, Ujjivan Small Finance Bank, etc., transformed themselves into banks in recent years.

Fintech factor: Fintech companies also started providing payment solutions and taking away the opportunities of some significant cash transactions taking place through banking platforms and thereby, increasing the risk of losing some part of the growth in banks’ low-cost (CASA) deposits.

The emergence of larger PSBs: Consolidation of public sector banks (PSBs) has led to the emergence of eight large PSBs. They are likely to slowly start intensifying their competition with the private banks.

Rising financial inclusion: Banking penetration among the population has attained an almost near-optimal level – thanks to demonetization and direct transfer of subsidies to the beneficiaries, it is quite difficult to see any family which doesn’t have banking accounts in the urban settings. Even in rural India, the banking penetration got a tremendous boost in the last 6 years.

Conclusion

While many such structural changes have happened in the banking sector and intensified the competitive scenario, this sector couldn’t find any new areas for solid growth.

It is most likely that the single-digit growth rate in the banking credit base would remain the new norm for several years to come. More small finance companies are set to evolve themselves as commercial banks and a few more fintech companies are set to enter the financial transaction businesses in the years to come.

NBFCs are likely to lead in terms of faster lending growth. Post-major consolidation, the PSBs could opt for equity dilution to invite private stakeholders and also likely to attract successful leadership at the helm.

Of course, the banking industry would certainly remain the growth sector for the years to come. But it is most unlikely that the banking stocks would see any significant upgrade in their valuation multiples. Thus, the banking sector’s superior dominance in the benchmark equity indices and their rich valuation multiples (price to book values) are set for a major review.

(The author is the Founder & Head of Research, Equinomics Research & Advisory Pvt. Ltd)

Disclaimer: The views and recommendations made above are of the author and not of MintGenie.

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First Published: 04 Apr 2022, 05:31 PM IST