Asset Quality Resilient, But Loan Growth Moderate
India's banking sector is set for a potential re-rating as asset quality remains resilient, but loan growth may remain moderate, according to a report by Kotak Institutional Equities. The report highlights that asset quality is unlikely to be a concern in the near term, with both public and private sector banks expected to report lower slippages. However, banks may increase coverage buffers as they transition towards expected credit loss (ECL) norms.
"Valuations remain attractive despite recent outperformance, with scope for multiple expansion and earnings compounding," the report noted.
Retail and Unsecured Lending Outlook
Kotak noted that retail loan quality has strengthened compared to FY23 and pre-COVID levels, supported by tighter underwriting standards since FY24. "Unsecured lending should see the sharpest improvement following prior stress," it added. The improvement in underwriting practices has bolstered asset quality in the retail segment.
Loan Demand Uncertainty
The report flagged some uncertainty around loan demand. It said that while foreign fund inflows could help lower the cost of funds by reducing banks' reliance on deposits, they may not necessarily translate into stronger credit growth. "We are a bit skeptical about the loan demand situation and believe that the strong flow of foreign funds is likely to reduce the cost of funds as it would lower demand for deposits than boost loan growth," it added.
MSME and Corporate Loan Segments
On segmental trends, MSME loans are expected to face some stress if an economic slowdown continues for a longer period. However, there is no widespread or system-wide risk at present, supported by government guarantee schemes like ECLGS and CGTMSE. Large corporate borrowers continue to remain financially stable, with banks comfortable extending credit despite near-term sectoral uncertainties.
Overall Outlook and Recommendations
While benefits from improving funding conditions may vary depending on banks' growth strategies, the overall outlook remains constructive. "We see scope for multiple expansion alongside steady earnings compounding. Within this context, we maintain a relative overweight stance on frontline private banks," the report said.
