Banking Sector Earnings Outlook

Welcome to our weekly newsletter, where we bring you the latest insights and trends from the world of finance. This week, our focus is on the upcoming quarterly earnings season, with particular emphasis on the banking sector. It appears that listed firms are poised to deliver another impressive set of numbers, although the pace of growth may vary across sectors. Amidst the noise and excitement, we have identified two key data points that can provide valuable insights for investors.

Data Point 1: Loan Interest Rates

The share of loans with interest rates of 9 percent and above has risen to 56.1 percent as of January-March FY23, up from 39 percent in the previous quarter (FY22 Q4). This data point highlights the scope for bank earnings this season. Banks generate revenue by charging interest on loans they provide and paying interest on deposits they receive. The difference between the two is their earnings. While the potential for further lending rate increases is limited, as much of the policy rate hikes have already been transmitted, the significant rise in loans with higher interest rates may impact credit growth. Banks would likely prefer to avoid endangering the robust credit growth currently underway.

Data Point 2: Deposit Interest Rates

Nearly two-thirds of bank deposits carry an interest rate below 7 percent as of FY23 end. This data point suggests that there is room for repricing and signals the possibility of future deposit rate hikes. The gap between deposit and loan growth remains substantial, and the growth in low-cost current and savings account deposits has slowed. Early business performance updates from select banks for the April-June quarter indicate this trend.

The implications are that bank earnings may face pressure, and analysts are already noting a compression in net interest margin. However, despite the challenges, the sheer growth of banks' balance sheets provides them with sufficient momentum to deliver sustained profits, and in some cases, even better profits than before. Analysts at Kotak Institutional Equities project a 58 percent year-on-year jump in the aggregate net profit of the banks they cover. This optimistic outlook is primarily driven by reduced incremental provisions due to a decline in non-performing assets. Moreover, strong loan growth contributes to a robust net interest income.

Banks have learned valuable lessons from the previous bad loan cycle and are approaching new risks with caution. As shown in our "Chart of the Day," banks have scaled back on risky microfinance loans in FY23, although they are slowly returning to this segment. This cautious approach is evident across various sectors, including infrastructure.

While bank earnings seem to be on a fast track, lenders are exercising prudence and ensuring they have their seatbelts securely fastened this time. They remain vigilant for any unexpected turns that may arise, aiming to avoid potential challenges. The most intriguing aspect of the first quarter's earnings will be whether bank leaders shift gears for greater momentum or continue with a measured approach. Much depends on the road they see ahead in terms of deposit growth and the potential speed bumps they may encounter due to external factors.