India’s banking sector seems to be slowly limping back to growth, given the favorable underlying fundamentals, but for global research firm Jefferies, there exists some pocket of concern and, hence, is sticking to private banks, namely ICICI Bank, HDFC Bank and IndusInd Bank as its preferred investment choice.

Jefferies has listed several factors including growth uptick amid continued support from the government and the Reserve Bank of India (RBI); negative real rates drive mortgage demand; potential for new banks; holdco norms as a base case scenario for maintaining positive outlook on the sector.

However, Jefferies sees concentrated growth among stronger banks/NBFCs as well as scrutiny of the asset quality to be the key for future guidance.

“Asset quality will be compared with guidance and buffer-provisioning levels. We build in a surge in downgrades in 2HFY21 and FY22, but with buffer provisions, built-in credit costs should normalise soon,” Jefferies said in a report.

Further, it expects an uptick in fees and a rise in net interest income (NII) to drive operating profits in FY22. Coupled with a normalisation of credit costs, Jefferies expects a 38 percent YoY rise in FY22 for private banks’ profit, albeit from a low base.

Private banks have raised more than USD 7 billion and PSU banks' needs seem manageable around USD 10-13 billion, it noted.

“Use of recap bonds or infusion by LIC may be useful. Still, this may be dilutive for existing investors,” Jefferies said.

The brokerage house expects higher commodity prices and a retail uptick should boost credit growth to 7.5-8 percent, with larger lenders benefiting more.

It also expects private bank profit may rise by 38 percent in FY22, from a low base.

“The real rates have turned negative for the first time in seven years. Coupled with improved mortgage affordability, this is driving housing demand growth in India and globally. However, low rates will also drag deposit growth and narrow the wedge between credit-deposit growth,” Jefferies said in a report.

Meanwhile, certain regulatory reforms announced by the RBI will bode well for the banking sector going ahead, according to Jefferies.

RBI has been open to giving new bank licenses. There have been suggestions for licenses to be granted even to corporates and that encouraging NBFCs to be banks will improve credit to SME, raise competition for deposits and privatize credit, it said.