The Indian financial sector is broadly divided into two key segments: banks and non-banking financial companies (NBFCs). While both play critical roles in credit delivery and financial intermediation, their business models, risk profiles, and income generation capacities differ significantly. These differences translate into varied valuation levels in the stock market.
In this article, we explore why banks inherently deserve higher valuations than NBFCs, with a specific focus on IndusInd Bank and Shriram Finance as a case study.
1. Diversified Income Streams: The Bank Advantage
Funded vs. Non-Funded Exposures
Banks earn from both funded (loans, advances) and non-funded (bank guarantees, letters of credit, trade finance) exposures.
NBFCs, like Shriram Finance, primarily rely on funded exposures. They earn interest on loans but lack significant fee-based income.
Non-Funded Exposure Income
Banks charge fees, commissions, and service charges for non-funded services. These include:
Bank Guarantees (BGs)
Letters of Credit (LCs)
Forex handling and trade documentation
Commitment fees on undrawn lines
This diversifies revenue and boosts Return on Assets (ROA) and Return on Equity (ROE) without increasing risk proportionally.
2. Cost of Funds: A Key Differentiator
Banks:
Fund themselves via low-cost CASA (Current and Savings Account) deposits.
Access RBI liquidity windows and benefit from systemic trust.
NBFCs:
Depend on market borrowings, bonds, or bank lines.
Face higher cost of capital, often 8–10% or more.
Vulnerable during tight liquidity cycles, as seen during IL&FS and COVID crises.
Result: Banks enjoy better spreads and capital efficiency.
3. Regulatory Advantages
Banks enjoy direct access to RBI’s repo window, payment systems, and priority sector benefits.
NBFCs are more exposed to regulatory shifts and funding disruptions.
Banks also benefit from public trust and deposit insurance.
These factors provide banks a more stable and sustainable growth model.
4. Valuation Case Study: IndusInd Bank vs Shriram Finance
Shriram Finance:
Strong in vehicle finance and retail lending.
Limited to funded credit segments.
Higher cost of capital.
Limited ability to grow outside their niche without significantly increasing risk.
IndusInd Bank:
A diversified private sector bank with improving ROA and solid digital + retail growth plans.
Access to low-cost deposits and non-funded fee income.
Acts as a full-service financial platform (corporate + retail + trade).
Potential to scale with lower incremental capital.
Valuation Disconnect: Despite structural advantages, IndusInd has often traded at or below Shriram Finance’s valuation multiples due to past management perception and legacy asset quality issues. As these concerns ease, IndusInd's superior business model and return metrics should drive a valuation re-rating.
5. Return on Invested Capital (ROIC) Edge
Non-funded exposures earn fee income without capital deployment, making ROIC structurally higher for banks.
NBFCs must lend to earn, tying up capital for every rupee earned.
A well-run bank will thus generate higher returns per unit of capital, especially when managed prudently.
Conclusion: Banks Deserve to Trade at a Premium
The market often misprices entities during temporary phases of uncertainty. However, structurally:
Banks have a superior business model.
Diversified and fee-driven income provides resilience.
Lower cost of funds and better capital access boost profitability.
Higher ROIC and ROE potential justify a valuation premium.
IndusInd Bank vs Shriram Finance: Final Thought
Given the above, IndusInd Bank deserves to trade at a premium valuation to NBFCs like Shriram Finance. As investor confidence returns and asset quality remains stable, the mispricing should correct, rewarding patient investors who understand the long-term structural advantage of banks.
Disclosure: Always do your own research and consult with financial advisors before investing.
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