Indian banks outperformed global peers on financial parametersIndian banks have outperformed global peers on financial parameters, driven by strong profitability, higher growth expectations and prudent risk management, according to McKinsey & Company.

However, expansion in yield may be limited due to slow deposit growth and an increasing proportion of credit-tested customers, per the report ‘Indian Banks: Building Resilient Leadership’. 

The report is based on the performance of 80 banks over the last five years.

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The banks led with healthy credit growth of 10-11 per cent over the last decade, with higher ROA (return on assets) than global peers, resulting in a valuation premium with higher Price-to-Book (P/B) multiples, McKinsey said.

The top three banks in India enjoyed P/B multiples of 2.5, compared to P/B multiple of 0.5-1.5 for banks in other major geographies as of Q1 FY2023.

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McKinsey assessed that Indian banks’ profitability is higher than pre-pandemic levels, with resilient NIMs (net interest margins) and declining credit costs contributing to healthy margins.

Over the last decade, NIMs have remained high (around 2.9 per cent in March 2022, rising from around 2.5 per cent in FY18) due to increased penetration of retail lending and a significant proportion of floating rate loans driving faster transmission of rate changes, which has led ROA (return on assets) to touch around 1.1 per cent in March 2023.

A granular and diversified deposit base relative to global banks has helped lower risk.

McKinsey analysis shows that around 82 per cent of the total liabilities for Indian banks are funded through deposits, as compared to around 60-75 per cent for banks in the US and EU as of December 2022. About 70 per cent of total deposits come from individuals and households.

Asset composition

McKinsey noted that the asset composition of the banks is becoming more retail-focused, leading to lower concentration risk.

Private-sector banks grew fastest, at a CAGR (compounded annual growth rate) of 21 per cent over the last five years. But credit deployment to the industry was almost flat, growing at 1-2 per cent per annum over the last five years.

The report emphasised that India has historically had a high credit growth multiplier to GDP vis-a-vis other countries. From 2000 to 2020, India’s credit multiplier was 1.9 times, higher than the world average of 1.2 times.

Different segments have contributed to this growth at varied times – the first half of the early 2000s was dominated by corporate lending. In comparison, retail lending outperformed in the second half of the 2010s.

Further expansion in yield may be limited

While banking RoAs have been healthy, multiple trends could exert downward pressure on banking profitability over the next three to five years, like slower deposit growth, an increasing proportion of credit-tested customers, fee income decline and rising operational expenses.

As per McKinsey’s analysis, there are new opportunities for banks to drive growth soon. They could expand into under-penetrated rural and agri segments and tap into the fast-growing digital commerce opportunity (CAGR of ~30-35%) driven by ONDC (open network for digital commerce) and OCEN (open credit enablement network).

Further, Banks can democratise wealth management for mid- and mass-affluent segments (likely to grow at 13-15% annually by FY27) with investments in digital capabilities to serve this growing segment.

Peeyush Dalmia, Senior Partner, McKinsey & Company said, “While Indian banks have remained remarkably strong through the recent volatility, they can no longer rely solely on financial benchmarks and must address other financial and non-financial metrics.

“To improve performance, the industry will require investment in digital capabilities to service the growing mid and mass-affluent; focus on new opportunities such as digital commerce and financial inclusion in the rural sector; and build on tech resilience and digital & analytics capabilities. Attracting the right talent for specialist functions, primarily in tech, digital and analytics roles, has also emerged as a priority, as banks rethink their overall employee valuation proposition.”