Bank of India MF CIO Alok Singh sees banks poised for a re-rating. Here’s what could trigger it

India’s banking sector stands at a pivotal juncture, with strong fundamentals and reasonable valuations setting the stage for a potential re-rating, according to Alok Singh, Chief Investment Officer at Bank of India MF. The realization of this upside depends heavily on sustained macroeconomic performance, particularly a revival in the corporate capital expenditure (capex) cycle.

Economic Triggers for Growth

The primary catalyst for a banking sector re-rating is continued economic expansion. Singh identifies sustained GDP growth above 7% as a critical factor. This, combined with an anticipated pickup in corporate capex, is expected to fuel credit demand and bolster bank performance. The banking industry is viewed as a direct proxy for the health of the Indian economy, and a strong growth environment would directly translate to improved prospects for lenders.

Strengthening Financial Health

Indian banks have significantly improved their financial standing, boasting well-capitalized positions and clean balance sheets. Asset quality has seen a marked improvement, leading to lower credit costs. This is reflected in strong profitability metrics. Private sector banks are reporting Return on Assets (ROA) above 2% and Return on Equity (ROE) exceeding 17%. Public Sector Undertaking (PSU) banks are also showing considerable progress, with ROA nearing 1% and ROE reaching 14-15%.

Credit Growth and Deposit Competition

Overall credit growth is robust, running at approximately 15-16%, largely propelled by strong retail demand. While corporate credit growth is beginning to show early signs of recovery, a significant challenge remains on the other side of the balance sheet. Deposit growth has lagged behind credit expansion, sparking intense competition among banks for funds. This rivalry is pushing deposit rates higher, which could exert pressure on Net Interest Margins (NIMs) across the sector.

Valuation and Market Outlook

Currently, banks are trading at valuations that are in line with or slightly above their long-term average price-to-book values, suggesting they are not over-priced. The potential for a re-rating exists if the positive economic and financial trends continue. PSU banks, in particular, are seen as candidates for improved valuations as their financial metrics converge with those of their private-sector peers. The outlook remains positive but conditional on the materialization of the corporate investment cycle and stable margins.