Major headwinds are persisting for banking sector

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Investors are feeling quite positive about the banking sector. Even FIIs have become buyers in April. Bank Nifty has gone up 8.24% in the last one month. Major factors for the sector are cleaner balance sheet of corporates, RBI pausing rate hikes and improved asset quality of banks. 

The results of financial companies like ICICI Bank and IndusInd Bank were good. This gave a positive start to the earnings result session. 

 However, going ahead few headwinds can create turbulence in the smooth ride of the banking sector. Nomura stated in its report that credit growth in FY24 will be 10% while in FY23 it was 15%. Major reasons were slowing economic growth and a fall in working capital needs as WPI cooled off. 

 So what could be the challenges for banks ahead? Let’s have a look. 

 If the working capital requirement falters then banks would rely on capex demand along with demand from the retail sector.  

Private capex 

We are expecting a boom in it. Capacity utilisation in India is close to 75% and manufacturing PMI is in the expansion zone. The government is creating an ecosystem by PLI schemes, focusing on logistics and infrastructure. It has allocated a higher budget for capex spend.

Still, it might take one or two quarters to see a boom. Business Confidence Index by NCAER reported improved sentiment regarding production but their prospects of the labour seems stagnant. So, this indicates no significant capex or huge fixed asset investment as firms doen’t seem enthusiastic about increasing labour count. 

Also after covid, companies know transition and churning is happening at quick pace. So there is a focus sustaining competitive advantage by spending on innovation, digitisation, brand building, expanding distribution channels, improving supply chain resilience etc. These activities are effectively capex but in accounting terms, they are be seen some of these activities are considered just as an expense while other are qualitative factors so they are not accounted for at all. 

Even if they are investing in fixed assets that would be considered as capex, we have to see how much they will borrow from the market and how much from banks. Financial markets right now are more developed than 2003-2007, the last time we witnessed capex boom. So, companies may prefer markets more than banks because banks have more covenants. 

Rretail segment

RBI reported in its “State of Economy” report that retail loan growth has been strong, it grew 20.4% in February due to demand for housing, auto and other small ticket demand. 

Even though inflation is cooling off and RBI is not expected to raise rates further, the common man takes time to realise positive changes. On top of it, there is a K-shaped recovery in the Indian economy. The unemployment rate is high, GDP growth rate estimate for FY24 is lower than FY23. The rural economy is yet to find its footing and it may face issues due to El-nino. So all these factors can be a headwind for continuous growth momentum. 

Moves in market

Markets are favouring the banking sector right now. So, either they are ignoring these issues, or they are being very forward-looking and focusing on long-term structural growth in India where banks would play a pivotal role. It seems there is a combination of both.