Indian Banks—An Attractive Secular Growth Story

 

July 1, 2016 [India, Banking, population, Emerging Markets]
Pablo Echavarria, CFA


Despite meaningful progress over the last four years, large chunks of the Indian population remain unbanked. The total number of unbanked Indians stood at 233 million in 2015, down from 557 million in 2011. That’s more than the populations of Germany, the United Kingdom and France combined.

India

After three years of painful returns, emerging market equities in 2016 appear to have regained their footing. The MSCI EM Index climbed nearly 5% over the first six months of the year, handily outperforming major advanced country stock indexes, despite slowing economic growth in China, a political crisis in Brazil, and continued financial sanctions on Russia. Perhaps investors are looking past the headlines at the exciting long-term growth stories across many of the developing world markets in which we invest. We believe many of the structural growth stories that we have talked about over the years remain intact, and will continue to provide long-term investors with opportunities for strong returns.

The Indian banking sector is one of these stories. India is the second-most populous country in the world, with 1.295 billion at the end of 2014, according to the World Bank. India’s population continues to grow, the result of a relatively high fertility rate and improving life expectancy, which stood at 66.2 years at the end of last year, up from 41.4 years in 1960. And while its fertility rate of 2.5 births per woman has been declining, it remains meaningfully higher than China’s, at 1.66. As a result, demographics in India continue to be attractive, with the United Nations projecting that India will become the most populous country in the world by 2022. Despite meaningful progress over the last four years, large chunks of the Indian population remain unbanked. PriceWaterhouseCoopers India recently released a report estimating the total number of unbanked Indians stood at 233 million in 2015, down from 557 million in 2011. That’s more than the populations of Germany, the United Kingdom and France combined. Reducing the percentage of India’s unbanked population remains a priority for Prime Minister Narendra Modi’s government, which in 2014 launched an ambitious financial inclusion program called Pradhan Mantri Jan Dhan Yojana (PMJDY). The program seeks to facilitate banking services for every Indian household. More importantly, even for the population that is already banked, penetration of credit services remains relatively low. According to the Bank for International Settlements, India’s household debt as a percentage of its gross domestic product stands at a mere 10.1%, which is far less than in other emerging markets, including China (39.5%), South Africa (37%) and Turkey (21%). We recently had a call with a developed market bank in which the discussion centered around whether loan growth would be 3% or 5% next year. For Indian banks, the opportunity to grow loans in the double-digit range for years to come remains quite evident. Private Banks are in an even better position to take advantage of these growth prospects. The Indian banking system remains predominantly controlled by state owned banks, commonly referred to as PSU banks, which as a consequence of the 1969 nationalization of the banking system still control approximately three-quarters of banking sector assets.

Private sector bank licenses were reissued in the early 1990s to a select group of players, which since have been increasing their market share at the expense of their less-efficient public sector peers. Driven by better service offerings and more dynamic marketing campaigns, private sector banks have become the preferred banking partner to young working-class Indians. Banks including HDFC Bank, Indusind Bank, Kotak Mahindra and Yes Bank have managed to grow their loans in excess of their public sector peers over the last couple of decades, while maintaining strong credit quality metrics and high returns.

Going forward, we believe that technology advances will be crucial in private bank efforts to continue to gain market share. While branch build-outs continue to be important, we think greater penetration of smart phone devices is changing the manner in which people perform their banking activities. This is clearly a focus for most private banks in India, which are actively exploring different ways to reach the large unbanked population. On that note, it was interesting to see Yes Bank highlight it had reached 3 million followers on Facebook in its last investor presentation.

For emerging market investors, Indian private sector banks have provided impressive returns over the last ten years. For example, HDFC Bank, one of the largest private sector banks, returned a total of 456% from January 2006 to January 2016. The results were even more encouraging for some of the smaller banks, including Yes Bank, which returned 621%, while Indusind Bank gained 1119%. In the investment management industry we know that past returns are not a guarantee of future gains, But for the Indian private sector space, we believe the building blocks are clearly in place for continued strong returns for years to come.

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