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Notwithstanding the strong fundamental performance by Indian banks in CY23 (reflected in decadal high return ratios, strong asset quality and healthy growth), the year ended with modest relative returns for the sector and underperforming the benchmark Nifty – Niftybank 12%, Nifty Pvt Bank 14% vs Nifty 20% (barring Nifty PSU Bank Index which was up 32% ). In our view, this modest show can be attributed to multiple reasons– doubts on FY25/CY24 revenue growth as NIMs moderate, emerging concerns on unsecured lending, competitive onslaught in retail loans, slower liabilities momentum and probably, a tighter regulatory stance.

While the above factors have led to a derating for some strong franchises, we believe sector remains well-placed to deliver healthy medium-term returns given improving credit demand (which is likely to be well-rounded), healthy balance sheets (excess provisions and well capitalized). Liabilities (and the quality thereof) remain a joker in the pack and will continue to differentiate the men from the boys in our view. We believe growth acceleration (possibly aided by capex uptick) will lead to rerating of the frontline names in the sector.

Our preference leans towards larger banks – ICICIBC, AXSB and IIB are top plays. Bandhan is possibly the only bank in our coverage where credit costs have meaningful room for improvement and hence RoA could improve materially. PSU banks remain beneficiaries of a benign macro and we like SBI and BOB in our PSU banks coverage.

* Well-balanced growth likely over next 2-3 years: We expect healthy credit growth riding the long-awaited capex upturn in the economy as well as the retail lending opportunity. Growth impulses remain healthy and we expect credit demand to grow at mid-teens over the next 2-3 years with greater contribution from corporate credit incrementally. Retail lending, which has been doing the heavy-lifting over past few years, should continue at a healthy pace as well led by buoyant housing demand. We expect our coverage to deliver 17.4% CAGR in loans over FY23-FY26E.

* NIMs a transient discussion; asset quality healthy: We believe NIM performance is a transient discussion with respect to stock prices and key medium-term price drivers are growth and asset quality. The sector is well-placed on both fronts and we believe quality liability franchises should be able to manoeuvre the interest rate trajectory well (up/down). We forecast moderation in NIMs for most banks by FY26 (building 25-50bp rate cuts by then) which can be offset by lower opex growth and possibly steady credit costs to ensure healthy RoAs for our coverage universe. Also, most frontline banks have sizeable excess provisions (0.3-1.3% of loans) which should shield them in event of any unforeseen credit shocks.

* Valuations offer comfort; prefer larger franchises: Retail banks are trading at ~17% discount to long-term averages and we believe this offers an attractive entry point for long-term investors. Private banks are trading at ~6% discount to long-term averages while PSU banks have seen meaningful improvement in valuations (30%/22% premium to 5/10yr average) given that RoAs have normalized. While incremental valuation upsides are contingent to RoA upticks for PSU banks, a benign macro should aid stock performance. In our view, sector also remains a beneficiary (or bears the brunt of) the volatility in foreign flows and thus we believe any pullbacks due to the same could be opportunities to add exposure to select names. Our preferred plays are ICICIBC, AXSB, IIB.

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