What is the private banking market construct looking like now that most of the earnings are out? What is the SWOT analysis like?
Gaurav Kochar: So, on the banks that have reported numbers so far, the common trends are that the liquidity remains tight, the deposit growth in this quarter has been lacklustre. Having said that, Q1 is seasonally a weak quarter in terms of deposit mobilisation. The credit growth on a YoY basis has remained steady. I would say 14-15% kind of credit growth at a system level. While we expected the credit growth to come down in this fiscal, given that the deposit growth is in that 10-11% bracket, the credit growth would probably end the year at around 13%.
It was already known that credit growth will moderate from the last year, we are talking about 16-17% credit growth, which tapered down to 15% till about the end of FY24 and now we are talking about 13-14% credit growth. That was one common phenomenon across banks. The other bit was some bit of normalisation in asset quality. While it is nothing alarming as yet, in certain pockets we are seeing some slippages build up.
We need to see whether this continues in the coming quarters as well, because Q1 is seasonally slightly weak on asset quality, especially on the retail side. We will have to wait and see a few more quarters whether the numbers that we are seeing right now is just one-off or the trends are worsening.
Will this pressure on liability franchise continue and will this have an impact on the margins or do you think banks will be forced to increase rates?
Gaurav Kochar: Yes and yes. The pressure on margins continues. We speak to banks and they have been highlighting that the funding cost has been a key challenge, more so because the mix within the liabilities is…, the CASA as a percentage of liabilities is coming down, which is an indication of again a tight liquidity environment.
The funding cost from here on as we speak is rising. The mix is also changing more towards term deposits and wholesale deposits, which will again impact the cost of funding for the banks. Having said that, the margins from where we see it, if you look at consensus numbers, most of us are building margin decline for the next couple of years driven by funding squeeze, driven by rate cuts happening probably towards the end of this fiscal and overall mix in liabilities changing. So, part of that is already in the numbers. Whatever we have seen on the margin side from banks has been broadly in line with expectations. But to answer your questions, whether this tightness in the liquidity will continue, the answer to that is also yes. Perhaps if you look at the liquidity tracker that we use for banks, CD ratio is one that we use. If you look at the CD ratio at a systemic level, it is at 78-79%. Largely, if I look at the historical data of the last 10-20 years, this is where this number has peaked, after which two things happen, either the loan growth slows down or to match the credit growth, the deposit growth needs to pick up which will again indicate that the price of deposits may keep moving up to meet the credit demand. So, to answer your question, yes, the liquidity tightness will continue in the near term.Are you talking about all of this in the backdrop of the RBI circular?
Gaurav Kochar: That is different. Coming to the circular, while these are draft guidelines, draft circular, we will have to wait and see how the final paper comes in. But maybe this is perhaps on the backdrop of what happened. We are all guessing this is on account of what happened with the Silicon Valley Bank in the US and there was this liquidity squeeze on the bank. If we look at Indian banks, while I understand that Indian banks are differently placed, if you look at the balance sheet, what happened with SVB was more of the ALM mismatch.
They borrowed short and the investments were in the long-term securities. In India, if I look at the Indian banks, almost a quarter of the balance sheet is into liquid assets. So, that will be a very differentiated. We already carry a lot of liquidity on the balance sheet. But perhaps we have seen RBI being a little more proactive on these things, be it on the asset quality side or on the liquidity side. To that extent, maybe this has come from that, that the liquidity on the balance sheet needs to be a little more tighter, a little more sort of liquidity on the balance sheet.
If I look at the total liquidity covered today, most of the banks have reported a liquidity coverage of 110 to 120, 125 percentage and if I assume that the draft guidelines are going to be implemented, it has an impact of around 10 to 15 percentage point on banks’ liquidity, which means that to maintain the current level of liquidity, they will have to increase the liquidity by another 10-15%, which will imply maybe a 1-1.5 percentage point kind of higher deposit growth from the current level or maybe 1-1.5 percentage point of lower credit growth because ultimately that is the money which will be deployed in the liquidity.
So, a 1.5 percentage point kind of higher deposit growth or 1.5% lower credit growth would imply some impact on the overall earnings. Different banks will see different challenges, but at a broader scale, I would say 3% to 5% kind of impact on overall bank earnings because of this if this gets implemented.
Which banks do you think are going to benefit in this kind of environment?
Gaurav Kochar: For banks with very strong liability franchises, large private banks, the large PSU banks, deposit mobilisation is not that big a challenge. While the challenge is real for all banks, but the larger banks relatively are better placed in this given that they have the distribution and they have the systems in place to grow their deposits, whereas the smaller banks will have to play the rate game, will have to up the rates more to give a little more delta over the large banks to get more deposits. So, funding costs will be the key differentiator in this cycle.
Which end in the financial space is cheap and looking attractive — insurance, brokerage, private banks? What to your mind is fitting that cut?
Gaurav Kochar: Valuations for the sector as a whole are still quite benign. I would not say they are rich, barring a few pockets in the capital market space, and rightly so. The growth there is significantly better. The capital market is a little rich on the valuation side. But having said that, if I look at private banks or banks as a whole, they are broadly trading at pre-COVID multiples.
The long-term average may be only a shade above the long-term average. So, valuations are pretty much there. If I look at the credit cycle, credit growth, their return ratios – ROA and ROE – are tracking quite well. We are probably at a decadal higher return ratios. So, in that context and given benign credit growth in double digits, the valuation looks very comfortable for private banks especially. Coming to insurance, again, insurance has been lacklustre. If I look at the last few years, they have not given much returns.
But having said that if I look at the return on embedded value, the ROEV for them has been quite strong. The growth, despite all the challenges that we have seen on the macro side both on the regulatory front and the tax tweaks that the government did in the budget last year, of that, still the growth seems to be quite good in the early teens to early to mid-teens kind of volume growth for insurers and in that context, the valuation looks quite steady. The valuation re-rating for the sector should continue going forward.