The market capitalisations of the four large Indian banks — HDFC Bank, ICICI, Axis and SBI — are up 30 percent over the past year, driven by investor expectations of improving asset quality. The stock prices of these banks were up in the range of 19-49 percent in the last one year.

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Analysts expect the coming 2-3 years for these banks to be driven by strong underlying earnings growth. Morgan Stanley expects 30-50 percent upside in these banks over the next 12 months and core pre-provision operating profit to grow at 22-25 percent CAGR for these banks between FY19-FY22. Macro variables — US and Indian rates and crude oil prices — are also supportive, it added.

The brokerage also expects stocks of these banks to trade at levels much higher than historical averages.

"Unlike in the past, where almost all financials would do well (or badly) together, we think this is a different cycle. We expect challenged NBFCs to continue to struggle with liquidity/asset quality. Business models premised on the asset side need to rethink their strategy and hence their stock prices will struggle. However, large banks with strong deposit franchises should gain share in profits and market cap. The performance of these banks could drive 25 percent upside in the broader bank index (Bank Nifty), even if we assume all other stocks (on average) are stable," Morgan Stanley said in a report.

A look at the broad Indian financials index since 2012 shows that these large banks made up 45 percent of the index in 2012, which dropped to 30 percent by April 2018. However, in the past year, the big four have recovered and their weight has increased to 36 percent.

"Since 2012, ICICI Bank, SBI and Axis Bank were affected by asset quality concerns and slowing core earnings growth. At the same time, smaller banks, NBFCs, and HFCs did very well on earnings as they were growing loans fast and attracting higher multiples. In turn, this saw the weight of the big 4 banks reduced in Nifty Bank, which later recovered after the share prices of these four banks gave robust returns," the report mentioned.

Axis Bank surged 49 percent in the last one year, while ICICI Bank advanced 45 percent. SBI and HDFC Bank added 23 percent and 19 percent, respectively in that period.

Morgan Stanley expects this trend to accelerate over the next 12 months and expect large banks' weight to return to 45 percent of the index. This will be driven by continued strength in large banks on loan growth/profitability and sluggishness in smaller names, it added.

"While the 4 banks have done well in the past 12 months, a likely pickup in earnings progression should drive further re-rating. A backdrop of easing rates and rapid loan growth should drive strong outperformance," it further said.

The current backdrop for Indian financials looks similar to that in 2003-2004 when banks were coming off a long-drawn NPL cycle. "At that time there was a sharp drop in credit costs and underlying growth picked up sharply. The global rates cycle also turned, driving up multiples for stocks that delivered growth. This drove material outperformance at Indian banks. We believe similar trends are emerging now," the brokerage observed.

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