Banks set for second leg of re-rating cycle

Indian banks are ready for the second leg of re-rating, driven by acceleration in their loan growth and, in turn, earnings upgrades, brokerage firm Morgan Stanley said in a report.

"The first leg is usually driven by expectations around better asset quality. As tail risks recede, stocks improve sharply to normalised multiples - this has already occurred over the past two years," the report said.

Going ahead, the brokerage house believes that the strong balance sheets of banks, fewer concerns over the macroeconomy, and improving capacity utilisation has set the stage for a rise in capital expenditure among corporates in 2023-24 (Apr-Mar) and 2024-25.

The rise in capital expenditure and strong profitability of corporates is expected to foster job creation, accelerate income growth, and drive more growth opportunities, even in the retail and small and medium enterprises customer segment.

In light of this, Morgan Stanlry has hiked its loan growth estimates for banks by 2 percentage points to 16% for 2023-24, and by 3 percentage points to 17% for 2024-25.

At the same time, it expects banks' credit costs to fall in the coming years as concerns over the growth of the macroeconomy ease. In addition, banks have improved their capital adequacy ratios and increased their provision coverage rations following COVID-19 related disruptions, which holds them in good stead.Morgan Stanley is positive on bank stocks that are not fully pricing in this loan growth upcycle, have access to retail deposits and high liquidity, and are well-equipped to increase their market share, in line with an improvement in the overall economy.