We had shared an earlier blog, ‘Why Mid-Sized Banks are strategically disadvantaged’ as they are forced to take on more risk in a business where success needs to be rooted in conservatism.

The collapse of Yes Bank will further widen the competitive gap between the leaders (SBI/HDFC/ICICI/Axis/Kotak) and the others.

1.       The leading Private Banks and SBI will further gain market share of deposits. During moments of panic, people will migrate to Banks that can be trusted the most.  We expect SBI and HDFC Bank to be the prime beneficiaries followed by the trio – ICICI, Axis and Kotak.  Mid-sized banks may need to pay higher interest rates to attract and retain customers which will further necessitate pursuing riskier Credit to maintain decent profitability ratios.  Greater risk-taking further amplifies fragility.   

2.       Mid-sized Banks will face pressure on growth/ROE as they will be challenged to raise Tier 1 and 2 capital.  Banks need to maintain regulatory capital.  There is a core Equity Capital of ~ 7.5% of “risk-weighted Assets” and there is “Additional Tier 1” and “Additional Tier 2” of ~ 1.5% each which is typically raised through Debt instruments.   Tier 1 and 2 helps reduce Equity dilution.  RBI has allowed the entire Tier 1 Capital of Yes Bank to be written off – which means debt investors have completely lost their Investment.  Hence, one can expect mid-sized Banks more challenged to raise Tier 1 capital from here on.   This will mean either accepting lower growth, paying higher coupon to attract Tier 1 or need to raise more core Equity capital.

We expect weakness in leading Private Banking stocks in the near term.   For market participants playing the short game, a credible hypothesis is that deposits will flow out of all Private Banks and move to PSU Banks till the Yes Bank collapse becomes a distant memory.   This could cause them to sell. 

However, as we are playing the long game, any significant weakness should provide the opportunity to add to our existing positions and buy new names which we do not own.   Well run banks, rooted in a culture of conservatism will be high probability 15-18% return compounding stories for long periods of time as they will continue to gain market share from weaker franchises