Small, mid-cap private banks on the rise: Emkay Global bets on Federal Bank, Karnataka Bank, Karur Vysya Bank

Small-cap and mid-cap (SMID) private sector banks have experienced a strong recovery in the post-COVID banking resurgence, marked by gains in credit market share, expansion in return on assets (RoA), and robust stock performance.

However, challenges such as sectoral headwinds in growth, margins, and asset quality — particularly in the unsecured loans segment — are compounded by increasing competition from large private banks, non-banking financial companies (NBFCs), and fintech players.

These pressures necessitate a strategic overhaul of business models and, where necessary, adjustments to management structures, according to Anand Dama, Senior Research Analyst at Emkay Global Financial Services Ltd.

Dama emphasizes that the next phase of growth and valuation re-rating for SMID banks will depend on their successful transformation into retail-focused institutions with a strong digital presence. At the same time, they must leverage their expertise in the SME and business banking (BB) segments while maintaining healthy asset quality and achieving a sustained RoA of over 1%, he said.

Most small and mid-cap (SMID) private banks have recently delivered steady credit growth, with standouts like Federal Bank, CSB Bank, RBL Bank, and IDFC First Bank. Others, such as Karur Vysya Bank, opted for measured but profitable growth, while underperformers like City Union Bank, Tamilnad Mercantile Bank, South Indian Bank, and Karnataka Bank faced regulatory and capital constraints, Dama noted.

Learning from past corporate asset quality cycles, many SMID banks have focused on building granular, diversified portfolios with a retailization strategy, safeguarding their SME strength through branch sourcing and partnerships.

SMID private banks with a favorable asset-liability mix (ALM) and a higher proportion of fixed-rate assets are expected to see limited margin impact when the rate-cut cycle begins.

“Despite higher CoD due to lower CASA, most SMIDs typically have healthy NIMs, ranging at 3.2% – 4.5%, with Federal bank at the lower end and CSB Bank at the higher end. However, a few SMIDs like RBL Bank, IDFC Bank, and SFBs in general command far higher NIMs, i.e. above 5%, due to their exposure to high-yielding unsecured loans,” Dama said.

Amid expectations of policy rate cuts, he believes banks such as RBL Bank and Karur Vysya Bank are better positioned to withstand margin pressures due to their higher share of fixed-rate assets.

Top Picks

Emkay Global believes SMIDs private banks are likely to be better placed on growth and margin as well as on the asset quality fronts (except the unsecured loan-heavy RBL Bank, IDFC Bank), amid rising sectoral headwinds, and thus still offer decent returns.

Amid SMIDs, Emkay Global’s top picks are Karur Vysya Bank with a target price of ₹325, and Federal Bank with a target price of ₹270, on the back of continued strong RoA delivery, better management pedigree, and limited asset quality risk owing to lower share of unsecured retail loans.

Karnataka Bank too has seen a decent turnaround with its RoA jumping to 1.2% from a low of 0.7%, but valuations are still highly attractive at 0.7x FY26E ABV, Dama said. Thus, the brokerage firm initiates coverage on Karnataka Bank with a ‘Buy’ rating and a target price of ₹300 per share and favors it over DCB Bank. It has dropped coverage on DCB Bank, given its prolonged sub-par return profile / performance.

Within SFBs, the brokerage firm likes Ujjivan Small Finance Bank, given its strong earnings buffer to absorb any intermittent asset quality disruption in the MFI space and still deliver healthy RoA, in addition to its potential transition into a Universal Bank.

Emkay Global said it recommends RBL Bank with a target of ₹250 for investors ready to trade near-term pain for long-term gain, as the ongoing transformation manifests via sustained RoA of above 1%.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.