Bonds, which account for 26 percent of the system credit, are expected to see a 10 percent fall in assets under management (AUM) in FY21 as it could lose attractiveness due to rigidity on servicing and volatility in inflows for their subscribers, said a report.

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Since 2019 and post the outbreak of COVID-19, the inflows into debt schemes weakened while the bonds have proven to be a highly rigid instrument versus flexibility of bank loans.

“This was because bonds need to be serviced on the due date even as bank loans could offer ‘moratoriums’. There is no scope for debt restructuring or additional working capital lines to cope with unexpected cash-flow mismatches and volatility into debt schemes has increased and bonds expose borrowers to external factors versus banks’ strong deposit franchises,” global brokerage Jefferies said in a note.

It is important to note that over the past 5 years, bond markets have seen a 13 percent CAGR better than domestic bank credit growth of 10 percent reflecting lower rates and increasing flows with subscribers. As a result, their share in system credit rose to 26 percent.

Jefferies believes that bond markets should see a 10 percent YoY decline in AUMs in FY21 and recovery to 7 percent in FY22.

This will be driven by refinancing of bond repayments through bank loans and increasing preference for bank loans among borrowers as its flexibilities that comes handy in uncertain times.

“Allocation of bonds will also polarize towards best-rated NBFCs/ corporates and lower-rated companies will be forced to shift to bank credit. Therefore, we expect banks to see 5 percent growth in domestic credit in FY21 and 8 percent in FY22 despite weaker growth in system credit,” the report added.

The report also noted that despite the weak economic activity, bank credit growth has been relatively stable and between February 2020 to April 2020, growth in banks' loans to corporate has risen from 3.5 percent to 6 percent, YoY, respectively.

Half of the banking sector will serve most of the credit demand. The brokerage believes that larger private banks, which account for 29 percent share in bank credit and SBI with 23 percent share, will address the majority of credit demand given their stronger deposit franchise and also better capital levels.

While the other PSUs are benefiting on the deposit side, it is expected that their limited capital levels, higher stressed loans and focus on integration on recent mergers will limit their ability to participate in the next two years of growth.