This article is a detailed rationale behind the smallcase Banking Privately. This smallcase is an intelligently weighted portfolio of private banking & NBFC stocks.
Let’s see why this smallcase looks promising for the long-term.
Overview of NBFCs in India
A non banking financial company (NBFC) is a monetary institution that performs most of the functions of a bank such as providing loans for various purposes, financial leasing, bill discounting etc. However, unlike banks, NBFCs cannot accept demand deposits or issue cheques drawn on itself. Based on the nature of business, NBFCs can be classified as – asset finance company, loan company, investment company, infrastructure finance institution, micro finance institution, factoring firm, infra debt fund or housing finance company. Housing Development Finance Corporation Ltd, Indiabulls Housing Finance Ltd and LIC Housing Finance Ltd are some of the largest listed NBFCs in India.
The NBFC sector in India has undergone a significant transformation over the past few years and is today seen as an integral part of the Indian financial system. NBFCs have played a key role in the development of the infrastructure segment. During the 12th five year plan (2012-17), 27% of debt financing for infrastructure sector is expected to flow in from NBFCs. They have also been providing credit to retail customers in under served and unbanked areas, playing a key part in advancing Governments programme of financial inclusion.
NBFCs have been building their business in areas like commercial vehicle finance and mortgage products. This is evidenced by increasing assets of NBFCs as a percentage of banking assets.
NBFCs usually target under banked segments of the population. This allows them to earn higher profits compared to banks, leading to higher return on equity.
Other secular trends like low credit penetration in India compared to other economies and low NBFC credit as percentage of GDP when compared to other middle and high income economies provides huge opportunity for NBFCs to grow. Boston Consulting Group expects NBFC credit to grow up to Rs.29 lakh crore by 2020 from the present size of Rs.12.7 lakh crore.
Overview of private sector banking companies in India
Currently, 21 private sector banks are operational in India. They have been at the forefront of adopting technology solutions like expansion of ATM networks and internet/phone/mobile banking solutions. They have also been hiring direct selling agents to sell credit products. This has allowed private sector banks to provide better services and amenities to the customer thereby allowing these banks to offer stiff competition to their public sector peers.
Private sector banks have certain other advantages compared to public sector banks (PSB).
While public sector banks account for close to 75% of total banking assets and 71% of total income as of end of financial year 2016, private sector banks have been growing their total income at a faster rate.
Economic down trend and higher inflation has led to a drastic drop in demand across various sectors. This has led to losses and companies have not been able to service loans that they had availed from banks. As a result, such loans turned “bad” and banks have had to write them off. Higher bad loans or non performing assets leads to lower profits and lower return on assets. Increasing bad loans also has a direct effect on the amount a bank is able to lend as loans. If banks are not able to lend larger portion of the deposits they have collected as loans their future profitability will also be adversely affected.
Though all banks have seen a rise in NPAs over the past 3 years, private sector banks’ bad loans are lower compared than that of public sector banks (PSB). Net NPAs of private sector banks increased from 0.66% in financial year 2014 to 0.89% in 2015. During the same period, NPAs of public sector banks ballooned from 2.92% to 5.75%. The effect of higher NPAs on return on assets is more prominent in case of PSB’s. Average return on assets of PSBs between 2012- 2017 was 0.31% compared to 1.22% for private sector banks. This has resulted in lower loan to deposit ratio of PSBs compared to private sector banks. Average loan to deposits ratio, between financial year 2012 to 2017, for PSB’s was 74.99% compared to 85.29% in case of private sector banks.
Expected revival in economic activity, softening of interest rates and relatively normal monsoon are all expected to improve prospects of banking sector going forward. Private sector banks, which are relatively well capitalised and more efficient, are expected to grow faster than PSBs.