Markets Ignore Weak Credit Growth As Bank Shares Scale Record Highs

Banks are doing very little of what they should be doing – giving loans. But the market doesn’t seem to care. While bank credit growth has lingered at historic lows since December, the S&P BSE Bankex, an index of bank shares, has continued to rally, hitting a historic high along with the benchmark indices.

Ashish Gupta, managing director and head of research at Credit Suisse, highlighted this divergence in a note on March 20, saying both credit and deposit growth have slowed but ironically the BSE Bankex has hit an all-time high.

Data from the Reserve Bank of India (RBI) shows that credit growth fell to 4.1 percent during the fortnight ended March 3, after having slipped to below 5 percent after demonetisation was announced on November 8. At the time, bankers had suggested that demand for credit would revive once lenders could shift their focus away from the note exchange programme but this is yet to happen. Deposit growth, too, has moderated to 12 percent after having hit a high of 15 percent in January.

Gupta’s note added that loan growth remains weak across all segments. Monthly sectoral credit data released by the RBI shows that credit to industry contracted 5 percent year-on-year as of January, while consumer loan growth slowed from near 20 percent in September 2016 to about 13 percent in January.

Why then is the market positive on bank stocks?

One reason is the divergence between the performance of private and public sector banks in terms of their ability to grow their loan books. Quarterly loan growth data from Bloomberg shows that the divergence in loan growth between private and public banks, which began in 2013, remains. As of the end of the December quarter, while private bank credit growth was at just under 18 percent, public sector banks were growing credit at a mere 3 percent.

“With a high cost structure (primarily wages), pressure on PSU bank profitability will intensify from this lack of loan growth,” wrote Gupta.

Fear of weak profitability among PSU banks is a key reason why a separate gauge of PSU bank shares remains well below all-time highs and has underperformed private bank stocks, which dominate the broader bank index in terms of weightage.

The premise behind the market’s optimism around private bank shares is two-fold. One, private banks will get a larger share of the business as under-capitalised public sector banks struggle. Two, strong growth in retail credit will keep the sector going till corporate credit demand picks up again.

In a note on Friday, CLSA’s Chief Equity Strategist Christopher Wood wrote that it increasingly appears that the Narendra Modi led government will leave the state-owned banks to address their problems.

“If this is indeed the case, it means there is a huge growth opportunity for the private sector banks to further take market share in the interim,” said Wood in his weekly Greed and Fear newsletter.

While this may be the case, Sanjeev Prasad, co-head of Kotak Institutional Equities expects even private banks to come under some pressure due to crowding in the retail banking segment.

Prasad sees weak growth in industrial credit demand continue for some time.

Excess industrial capacity and the nature of new infrastructure projects will mean that demand for industrial credit from banks will remain sluggish, Prasad said in a research note dated March 15. In this scenario, most banks will have to diversify into retail and SME credit, said Prasad while adding that this will need the market to shift its thinking on bank stocks.

“The market has bifurcated banks and NBFCs into retail and wholesale entities but we expect this to lose relevance as the corporate loan market will likely get dis-intermediated by the corporate bond market, leaving only the retail and SME segments for banks and NBFCs,” said Prasad.