Kotak Bank added, Axis dropped; ICICI, SBI, Federal Bank top Nomura’s picks

Foreign brokerage Nomura India has rejigged its top banking picks, adding Kotak Mahindra Bank Ltd and excluding Axis Bank Ltd. Now, Nomura's top large banks include ICICI Bank, State Bank of India, and Kotak Mahindra Bank, all rated 'Buy'. Among midsize banks, Nomura prefers Federal Bank, also rated 'Buy'.

The brokerage has analyzed the Reserve Bank of India (RBI)’s money supply data to understand the reasons behind the lagging deposit growth in the banking system over the past two years. While bank commercial credit, including corporate bonds, grew by 14% and 16% year-on-year in FY23 and FY24 respectively, system deposit growth lagged at 9 percent and 12 percent year-on-year, putting pressure on system liquidity.

Generally, credit creates deposits, and over the long term, both tend to grow at similar rates. However, this persistent divergence is concerning. Nomura's analysis indicates that the primary reasons for the slower deposit creation in FY24 were lower net credit to the government from the banking system and higher net non-monetary liabilities of banks.

Looking ahead to FY25, the brokerage believes that the positive impact on deposits from the JP Morgan bond index inclusion could be counterbalanced by a normal increase in currency circulation, which was not seen in FY24 due to the RBI's ₹2,000 note withdrawal.

Moreover, for a sustainable increase in deposit growth beyond our base case of 13 percent year-on-year (YoY) for FY25, there would need to be a significant rise in bank credit to the government or substantial forex asset purchases by the RBI. Without these, the liquidity coverage ratio (LCR) and loan-to-deposit ratio (LDR) will likely continue to constrain system loan growth.

It maintains a ‘value-focused’ approach amid the broader convergence in returns on equity (RoEs) across the sector, favoring more liquid banks.

The foreign brokerage has set the following target prices for the mentioned banks: ₹1,250 for Axis Bank, ₹195 for Federal Bank, ₹1,335 for ICICI Bank, ₹2,000 for Kotak Mahindra Bank, and ₹1,000 for State Bank of India.

The brokerage further noted that many investors mistakenly believe that money flowing into capital markets, such as stocks and mutual funds, adversely affects system deposit growth. However, this narrative is flawed because the funds moving into capital markets remain within the banking system. When an investor buys securities, the money transfers from their deposit account to the seller's account, which is still part of the banking system's monetary flow. Notably, capital market investments are already included in the Reserve Bank of India's (RBI) broad money statistics, ensuring they are accounted for within the system's overall deposit data, it pointed out.

As previously emphasized, Nomura's forecast anticipates commercial system credit to expand by approximately 14 percent in FY25F. Achieving a 14 percent growth in system deposits for the same period would necessitate a substantial rise in government credit or foreign exchange asset purchases by the RBI.

However, in our base scenario, the brokerage maintains an expectation of 13 percent year-on-year deposit growth for the system. This projection implies there will still be a disparity between system credit expansion and deposit growth, potentially leading to the persistent loan-to-deposit ratio (LDR) and liquidity coverage ratio (LCR) constraints for certain large private banks, in its assessment.

Nomura highlighted that while banks can boost deposits by extending commercial credit, this approach is incrementally LCR-negative because commercial credit doesn't qualify as a high-quality liquid asset (HQLA). Therefore, banks with lower LCRs (and typically higher LDRs) face constraints on their ability to grow loans.

"PSU banks still have higher LCRs vs private banks, although this has come down significantly over the past two quarters. We believe some of the large private banks with higher LDRs (e.g. HDFC Bank, Axis Bank and IndusInd Bank) may see a moderation in loan growth, and we reduce our loan growth estimates for these over the past two quarters," it said.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.