This May Soon Be India’s Seventh Largest Bank By Value. Here’s Why

Bandhan Bank Ltd. is close to overtaking Yes Bank Ltd. as India's seventh most valuable lender in just over four months of making its market debut.

Shares of the microlender-turned-universal bank have surged 88 percent since its March 27 listing on exchanges, as financial-inclusion-focused lenders have grabbed investor attention. In fact, Bandhan Bank briefly surpassed the market cap of Yes Bank last Thursday but failed to close above it. The stock is the best performing banking stock of the year, with a market capitalisation of over Rs 83,000 crore.

But what's driving the surge?

In the early years of growth for India's private sector banks, it was thought that a pan-India presence was essential for success. That may no longer be the only way to make a mark. The other strategy to succeed, as a Bernstein report points out, is to deepen the market.

Increasing reach in geographies where a lender enjoys a cultural and linguistic advantage—and which is usually untapped by top private banks—is a strategy successfully exploited by regional lenders like Bandhan Bank, AU Small Finance Bank and Equitas Small Finance Bank.

Financial-inclusion focused banks can drive growth by deepening their home markets, and the headroom is very significant despite being leaders, Gautam Chhugani, analyst at Bernstein, wrote in a note. “We will see these emerge as regional powerhouses.”

Their branch network is significant compared to large private sector peers. For example, Bandhan Bank has more branches in West Bengal than any other private lender. AU Bank has fewer branches than ICICI Bank but more outlets than HDFC Bank Ltd., India's most valuable lender, in Rajasthan.

In West Bengal, Bandhan Bank has a 4.2 percent market share in the number of branches, 3.4 percent in loans and 1.9 percent in deposits. For financial year 2017-18 alone, it received 7.9 percent of the total deposits—four times its overall share. Similarly, it had a 7.6 percent share in loans during the period.

However, if you remove government owned banks, Bandhan had a 28.5 percent share of branches in the state among private sector banks. Its loan share stood at 13 percent and its deposit market share stood at 10 percent when compared to private banks, shows data collated by Bernstein.

AU Small Finance Bank has also been gaining loan market share in its home state of Rajasthan, from 1.0 percent in FY13 to 2.6 percent in FY18. Equitas' branch expansion helped it mobilise deposits, increasing its market share, according to Bernstein.

All this points to a trend of increasing value being attached to regional as opposed to a pan-national presence, Chhugani wrote. “Expanding pan India is a fallacy, if you are financial inclusion-focused.”

What Works For Bandhan Bank

Bandhan Bank still largely offers high-yielding micro-loans, which contribute 85 percent to its total advances. It offers low-cost deposits—with current and savings account deposits contributing 35 percent. Together, these helped it garner the highest margin among banking peers at around 9-10 percent in FY18, according to Bernstein. It also had the lowest cost-to-income ratio at 35 percent, thanks to its “hub and spoke” model of using direct sales correspondents and associated bank branches. That gave it superior return ratios.

Sustained higher margins at 9.5-10 percent and low cost-to-income ratio at 37-38 percent is expected to drive earnings growth at an annualised rate of 39.3 percent by FY20, Kajal Gandhi, analyst at ICICI Securities, wrote in her earnings update for the bank. The brokerage expects a return on assets and return on equity to sustain at 3.5-4 percent and 20 percent, respectively. The stock, it said, will continue to trade at a premium.