Opportunity in banking industary

Hi guys,
My name is Manhar and today I am going to write on the opportunity I see in the banking industry.

Currently or GDP is 2.7 to 3 trillion dollar. According to IMF report India might reach the 5 trillion mark by fy 2026-27.
Now I have just observed a very interesting fact here. Our credit to GDP ratio is somewhere close to 50% or 60% and when I compare this with USA,JAPAN,CHINA all of them have close to 200%.
My overall broad view here is that once we reach 5 trillion we are going to have this percentage close to 70%-80%.
That means current credit is 1.48 trillion( I might be wrong here) and by fy 2027 it is going to be 3.5 to 4 trillion. So this comes out to be a 20% CAGR growth over the next 5 years.

How are we going to achieve this 3.5 to 4 trillion. My overall broad level understanding here is.

  1. Once the economy starts growing. There is a growth in the overall demand in the country and since there is a growth in overall demand in the economy company will want to increase there production capacity, they will start doing more capex and this capex is going to be funded by banks.
    Now if you see economy can only grow if GDP grows and GDP can only grow if inflation is low and if inflation is low the RBI rates are going to be low and if RBI rates will be low the loan rates will be low. Since the cost of money will be very cheap when an economy grows it is a sort of incentive for companies to take more and more debt.
    Company start taking more and more leverage and do capex to fulfill the demand. They make lots of profit and pay lots of interest on that.

    Since the companies get so highly leveraged once there is some crises it bursts like a bubble (currently what is happening with china in real estate space).
    Now if you try connecting the dots you will see most of the banks shifting their advance MIX more towards retail and MSME and trying to reduce the corporate exposure because most of the banks can see this.
    I am slightly going off topic please don’t mind, another major reason is the MSME segment is going to outperform in this growth phase and you can also see government backing this sector heavily.

  2. One of the major reason that our credit is too low is because most of the people in India are not included in the banking system.
    GOI of India is taking big steps for the inclusion of maximum people in banking system. Like the PLI scheme, introduction of RUPAY, Preffered lending and many more.
    An economy cannot grow without backing the financial sector and government of India is exactly taking the right decision in this space.

How is it going to benefit banking industry,
If you see closely everything is linked. Once the demand grows company start producing more, which results into more profit. More profit increases more employment and salary and more salary and employment results into more spending.
The savings of people start increasing when an economy grows. Per capita income goes up. All this excess money with people goes into the Banks.

Now if feel a good bank can easily grow their Liability side by 15% to 20% every year for the next 5yrs and advances by 12% to 15%.
This was an example of a good bank an aggressive bank can do a lot better because there is heavy sectoral tail wind here.

How can you make money out of this
During this fall if you have observed nifty is down by 18% and bank nifty by 22% from their all time high. Generally this ratio of nifty bank nifty fall is 1.5 to 2 times. But this time bank nifty is holding.
This time the private banks have given close to 91000 cr of net profit highest till date. Currently bank nifty is trading at a PE of 16. I feel most of the private banks are available at good discount.

1 If you are not good at investing and analyzing companies just buy BANKNIFTYBEES and forget it for next 5yrs. You CAN make around 12% to 13% CAGR for next 5yrs.
2.Want to make a little more money invest in top private banks or mid sized banks.
3 If you want to take the complete advantage of this opportunity invest in Small finance banks/NBFC whose major lending is to MSME and retail segment. I feel these small finance companies/NBFC can grow their loan book by 2x or 3x in next 5yrs. Big opportunity here.

Most of you might have a question that one bad loan by a bank can completely change the narrative.
I feel this is the major reason most of the banks are making their loans more granular and diversifying their risk. And I also feel that if the economy does good then companies make lot of profit and the chances of default decreases. But yes as I said one big crisis can have a big impact on banks but even this problem gets tackled as the banks will make lot of money in the next few years their balance sheet strength increases so during crisis the stronger banks are able to absorb such shocks.

Overall I feel this sector has a big opportunity and seeing the current valuations it makes it even more attractive. Please do your research before investing in any of the companies.

I would be very happy if @ diffsoft shares his view on this post. I really admire him a lot. Would be very happy if he can share his views here.

I have a request from moderators to not delete my post once again. This topic is a new topic but if you find this should not have been made please merge to some other topic but please don’t delete it.
I have gone through the community guidelines about 10 times now. Please don’t delete it. Thankyou

Just forgot I have one more point to add here. If you see historically after every US recession the Indian economy has done phenomenally good. I am investing in INDIA growth story are you going to.
Thankyou once again

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Dear @manhar

You have an amazing breadth of understanding for someone your age. Kudos on that. You line of logic is very solid on both points 1 and 2, and esp on 1. I wish I were even half as smart your age.

I deliberately don’t give my views on which stocks to buy/sell because if I hold them I fear I will give a flattering opinion and if I don’t, then I have no skin in the game to comment. I usually comment (without talking about a stock) when I feel my reasoning is strong and rooted in facts. So please do excuse.

You are absolutely right that credit has to expand for GDP to grow. And GDP has to expand for credit to grow. Credit has to be underwritten well otherwise the cost is too high to bear, like you said.

NBFCs and (Scheduled Commercial) Banks play differing yet important roles in providing capital to the economy; and are regulated differently. This industry makes money via size of stock (i.e. loans) and velocity of flow (i.e fees / payments / trading etc); both and esp the latter is getting upended by newer players with technology and digital channels for reaching customers. This is more clearly seen in South East Asia / China / Korea than here (digital only banks), - but you may want to bear that in mind.

Please do visit RBI’s website regularly and read their monthly bulletin, their weekly data releases, speeches, committee reports, accounting and such. Do this for a few years and you will attain mastery!

All the very best!!

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Typically I stray away from financials as they range outside of my competence.

Been looking to understand banking and financials slowly, this post has helped!

Well written.

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This is the exact thought process that has helped me stay invested in private banks even though their prices have been giving a lot of pain. Although I believe, India should not follow the footsteps of USA or JAPAN or CHINA, we can see that majority of the problems in USA and JAPAN have come from high levels of debt. If debt is used excessively and mindlessly, there is greater chance of our economy going in the dumps than a 5T economy. It is actually a good thing that India does not have such high levels of debt. Also the way this debt is distributed amongst the middle class and lower income group, the businesses and the government is quite sensible. Each group has enough income capacity to pay their debts, unlike USA or JAPAN, which have been increasing their debt for generations and leaving it to pay for the future generations.

I know debt is an important tool of growth but the most basic principle is generating a return more than the ROI, in order to make good use of the debt taken. But there is only a certain amount of debt that can facilitate growth. Lets say 100cr debt can make us 20cr a year, that is a very good return, but if someone was to take 10000cr debt, just because it is available to them, their numbers won’t add up and will result is great problems in the future. ( Only reason for not investing in any of the Adani Stocks.)

So as you rightly said, if India wants to become a 5T Economy, debt will play a vital role, but only if it is used judiciously. Banks will have to do a better job at calculating and analyzing the viability of the debt given and whether it will make money in the long term or just go to provisions?

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@diffsoft
Thankyou sir for taking out time and replying. Reply by all VP members acts as a source of motivation for me to work even harder. I have certainly noted down your input and will be working on it. Thankyou once again.

@GrowingAlpha
I am glad that this post helped you. thankyou

@ishu
Thankyou for sharing your views. My understanding here is that even if we want we cannot follow footsteps of CHINA,JAPAN,USA. For us to reach 200% debt to GDP is very very difficult. Even reaching at 70% to 80% is going to be extremely challenging and below 100% for an economy of our size is not very risky. The reason being for us to expand our debt is going to be challenging is we don’t have many big size banks in our country. If you see our FM keeps stressing on the point that we need 5 SBI size banks to achieve such economic growth. Secondly the government is also selling PSU banks to consolidate this industry and the entry barriers in this industry is very high. So I don’t think we have the capability to reach such high debt level which might harm us.

Secondly interest is a fixed cost so as the economy grows the more debt you take the more money you make that is why companies go heavily leveraged. The problem starts arising when demand slows down, economic rescission. In this case sales stabilize or go down but interest payment remains same and then companies go into problem. The example you gave that 100cr make 20cr so 10000cr makes 2000cr. So the debt size doesn’t matter the capability for a company to service debt matters. Summing up everything if our GDP goes to 5trillion then we have the capability to service debt up to 5trillion is what I feel.
Thankyou

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I did not think of it this way. This is a very interesting point of view. Will surely give it a thought.

Credit growth at 9 year high. Last year profit at all time high. This industry and the financial sector are at the begging of a multi year bull run. I feel the next 5 yrs are going to be the golden years for the Financial sector and especially banking industry.

I believe there are 3 banks which have the ability to outperform the banking industry in the next 4 to 5yrs. I would like to share the name of three of them and give a basic reasoning as to in which I have invested or not.

  1. IDFC BANK - This bank has the brightest chances of outperforming but my reason to not invest here is it is a completely growth stock and epically in banking where the probability of a bad quarter is extremely high if investor see the next 2 quarters not as per expectation the volatility on these type of stocks can take the prices close to 50% down. Since I invest 40% to 70% in stock which I am confident I cannot invest in stocks which such high volatility.

  2. FEDERAL BANK - This bank is a brilliant buy at 1PB and I have a view that the downside here is very low. The only problem they have is geographical risk. If you see they don’t have too many current accounts with them because kerela is an agriculture based economy and does not have big industries. For getting CA you need to have your branches PAN india. But technologically they are extremely good especially with their tie ups with neo bank. I have done a detailed analysis in this counter which I will post soon. You have to understand the middle east a little bit when analyzing this company because inward remittance is a big source of their money which comes form Keralite working in middle east. Just for add on info if you see the reason they go and work outside is because there is insufficient jobs in kerala for the skill set they bring.

  3. YES BANK - Considering the growth which it can deliver in future the valuations of it currently make no sense to me. I share my view on this counter on its respective forum so wont be writing to much here. Currently this bank is close to 70% of my portfolio and I am pretty confident of it reaching a 1 lakh cr mcap by 2025.

There are 2 more stocks which I believe have the potential and I am analyzing them currently. INDUSIND BANK and BANDHAN BANK.

Overall I feel there are going to be heavy tail wind and I hope to make a lot of money out of them. I also hold 2% position on IDFC BANK of my entire portfolio and I am extremely interested to understand federal bank a bit deeper and take position here in future.

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I agree with all the points.
IDFC Bank’s credit card business is doing well, and even they have to do tie-ups with neo-bank but the tech isn’t their forte. You also have to check BoB, which makes sense.

Their recent tie-ups with credit card services are a bit aggressive, for example, OneCard.
BoB, IDFC First and Federal bank were competing for their customer base.

I am invested in Federal bank for their books and risk management and the above-mentioned points.
Specially neobanks like Fi it took 5 mins for me to create an account.

Bandhan bank is scary sometimes, not because of stock price fluctuation but the loan book they carry and the interest rate, sometimes I feel like I am a crook being an investor in such banks is like making poor people fall into their debt traps.

So the brand value is not so great in Assam.

Recently, exited IndusInd. I feel HDFCBANK and FEDERALBNK is a much safer than other bank right now.

Another bank that one may consider is Karur Vysya Bank. Its an old generation private sector bank ( mainly focussed on MSMEs ) that faced a lot of asset quality and growth related issues in the last 10 yrs.

The bank is now turning a corner. The gross slippages in the last 3 Qtrs have been less than 0.5 pc of the loan book… which is a very good sign. NPA clean up is happening at a rapid pace. Even the loan growth is picking up. The management is guiding for 15 pc loan book growth going forward. Plus the Bank trading at extremely cheap valuations.

If the Bank the sustain the performance of last 3 Qtrs over the next 1-2 Yrs, a lot of upside can get unlocked here.

Disc : invested from Rs 69 levels. Biased.

Hi Guys Thankyou for your view,

I see banks offering 2 thing in a broad view 1 is product and 2nd service. So when I talk about retail customers for them service is a higher weightage than product. Like hardly people use net banking. The mobile app is the only thing which might have significance to retail customer. What matters to retail customer is service and affiliated products. Like IDFC offers 3in 1 with zerodha. If you have an NRI account with axis bank you cannot open account with zerodha.

Where as for corporate customer product has a higher weightage than service. Like in LVB bank if you add a beneficiary you can immediately transfer them money. In other banks it take 30min to 24hrs. How good is the bank in FOREX market. Success ratio in transactions. If you want to put standing instructions then banks need to have tie up with the service provider.

Most of the small banks don’t have a good presence in wholesale banking because they cannot afford to spend in technology and you can just grow to a certain limit if you are totally retail oriented. So when I say wholesale I am mentioning both liability and asset side. So these big NIM for small banks will come down as they grow bigger and it is going to be even more difficult as the grow.

My overall point is if you want to project the growth of smaller banks you cannot project on the basis of current growth. It keeps declining in banks as the grow bigger. Banks also have to raise money time to time to grow and if you see most of the small banks EPS is in single digit and shares price is double digit which means they already have many outstanding shares.

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