If there’s one sector that has infiltrated and impacts every other industry, it’s the Banking Services industry. No matter what a company might be manufacturing/creating and selling, they have to interact & do business with at least one entity from the BFSI industry, most commonly a bank.
The banking space comprises of not only public-sector & private banks, but also NBFCs. Let’s look at the entire industry to understand where exactly in the banking space do most of the opportunities lie.
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 (HDFC), Indiabulls Housing Finance., and LIC Housing Finance 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 MSME 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 Banks in India
87 private sector banks are operational in India including, local area banks, payment banks, small finance banks and foreign banks. Most of these banks 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 banks to provide better services and amenities to the customer thereby allowing these banks to offer stiff competition to their public sector peers.
Private banks have certain other advantages compared to public sector banks (PSB).
Compared to 2016, public sector banks have witnessed a drop in their market share – they now account for 62% of total banking assets (vs. 75% in 2016) and 58% of total income as of end of FY18 (vs. 71% in FY16). Private banks have indeed been growing at a faster rate.
Non-Performing Assets (NPAs)
Economic downtrend & 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 5 years, private banks’ bad loans are lower compared than that of public sector banks (PSB). Net NPAs of private banks increased from 0.7% in financial year 2014 to 2.4% in 2018. During the same period, NPAs of public sector banks ballooned from 2.6% to 8.0%.
The effect of higher NPAs on return on assets is more prominent in case of PSB’s. Average return on assets of PSBs between 2015 – 2019 was -0.46% compared to 1.02% for private banks. This has resulted in lower loan to deposit ratio of PSBs compared to private banks. Average loan to deposit ratio, between financial year 2015 to 2019, for PSB’s was 65.3% compared to 89.7% in case of private 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. As the Indian economy grows, the one underlying sector that fuels this growth is certainly going to reap rewards.
Within the banking industry, it’s the private sector banks that are relatively well capitalised, more efficient, and poised expected to grow faster than PSBs. Which is why we’ve created a smallcase that includes stocks of the most rewarding & promising NBFCs and Private Banks – which are best positioned to benefit from India’s accelerating economic growth.