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AU Small Finance Bank shares slip post downgrade by Kotak Equities - BusinessToday

AU Small Finance Bank Shares Tumble Amid Kotak Downgrade, Deposit Growth Concerns, and LIC Partnership Developments

In a significant development for India's banking sector, shares of AU Small Finance Bank (AU SFB) experienced a sharp decline on July 14, 2025, following a downgrade by Kotak Institutional Equities. The downgrade, coupled with worries over sluggish deposit growth and the bank's recent partnership with Life Insurance Corporation of India (LIC), has sent ripples through the market, highlighting broader challenges faced by small finance banks in a competitive landscape. Investors reacted swiftly, with the stock plunging by as much as 5% in intraday trading on the Bombay Stock Exchange (BSE), closing the day down by approximately 3.8% at around Rs 1,250 per share. This drop erased gains from the previous sessions and underscored the vulnerabilities in the bank's growth trajectory amid rising interest rates and regulatory pressures.

The catalyst for this market reaction was Kotak Institutional Equities' decision to downgrade AU SFB's stock rating from 'Buy' to 'Add', while slashing its target price from Rs 1,500 to Rs 1,350. In their detailed research note, Kotak analysts cited concerns over the bank's ability to sustain deposit mobilization in a high-interest-rate environment. They pointed out that AU SFB's deposit growth has been lagging behind its peers, with quarterly figures showing only a modest 12% year-on-year increase in the first quarter of fiscal year 2026, compared to the industry average of 15-18%. This slowdown is attributed to intensified competition from larger universal banks and fintech players, who are offering more attractive rates and digital conveniences to attract retail deposits. Kotak's report emphasized that without a robust strategy to boost low-cost current and savings account (CASA) ratios, AU SFB could face margin pressures, potentially impacting its net interest margins (NIMs) which currently stand at around 5.5%.

AU Small Finance Bank, which transitioned from a non-banking financial company (NBFC) to a small finance bank in 2017, has been a darling of investors for its rapid expansion in underserved markets, particularly in rural and semi-urban areas of Rajasthan, Maharashtra, and Madhya Pradesh. The bank has built a niche in vehicle financing, micro, small, and medium enterprises (MSME) lending, and gold loans, leveraging its grassroots network of over 1,000 branches and a customer base exceeding 10 million. However, the post-pandemic economic recovery has brought new challenges. Rising inflation and the Reserve Bank of India's (RBI) hawkish stance on monetary policy have increased funding costs, making it harder for smaller banks like AU SFB to compete for deposits without eroding profitability.

Adding to the narrative is the bank's recently announced partnership with LIC, which was intended to bolster its bancassurance business. Under this tie-up, AU SFB will distribute LIC's insurance products through its branches and digital channels, aiming to diversify revenue streams beyond traditional lending. The partnership, formalized in June 2025, is seen as a strategic move to tap into LIC's vast customer base and enhance cross-selling opportunities. Analysts believe this could contribute an additional 5-7% to the bank's non-interest income over the next two years. However, skepticism remains. Kotak's downgrade report questioned the immediate impact of this alliance, noting that similar partnerships in the past have taken time to yield results, especially in a market where insurance penetration is still low at around 4% of GDP. Moreover, regulatory hurdles from the Insurance Regulatory and Development Authority of India (IRDAI) could delay full implementation, further complicating AU SFB's growth plans.

Market experts have mixed views on the downgrade's implications. Speaking to Business Today, Rohit Sharma, a senior analyst at a Mumbai-based brokerage, opined that while the concerns are valid, they might be overstated. "AU SFB has a strong asset quality with gross non-performing assets (NPAs) at just 1.8%, which is better than many peers. The deposit growth issue is industry-wide, but the bank's focus on digital transformation could turn the tide," Sharma said. He highlighted AU SFB's investments in fintech, including its mobile app 'AU 0101' which has seen a 30% increase in user engagement, as a potential game-changer for attracting younger depositors.

On the other hand, critics argue that the bank's aggressive lending in high-risk segments like MSMEs could backfire if economic slowdown persists. Data from the RBI indicates that MSME NPAs have risen by 20% in the last year, posing a systemic risk. AU SFB's management, in a recent investor call, defended their strategy, stating that they have tightened underwriting standards and increased provisions to 75% coverage ratio for potential bad loans. CEO Sanjay Agarwal emphasized the LIC partnership as a "milestone" that would provide stable fee-based income, reducing reliance on volatile interest income. "We are committed to achieving 25-30% growth in deposits this fiscal year through targeted campaigns and branch expansions," Agarwal assured stakeholders.

The stock's performance reflects broader market sentiments. The Nifty Bank index, which tracks major banking stocks, remained flat on the day, indicating that the sell-off was specific to AU SFB rather than a sector-wide correction. Foreign institutional investors (FIIs), who hold about 35% of the bank's shares, were net sellers, offloading positions worth Rs 150 crore, according to provisional data from the National Stock Exchange (NSE). Domestic mutual funds, however, showed some buying interest, suggesting confidence in the bank's long-term prospects.

This episode comes at a time when small finance banks are under scrutiny. Peers like Ujjivan Small Finance Bank and Equitas Small Finance Bank have also faced deposit growth headwinds, but AU SFB's larger market cap of over Rs 80,000 crore makes it a bellwether for the segment. The RBI's recent guidelines on liquidity coverage ratios (LCR) and net stable funding ratios (NSFR) add another layer of complexity, requiring banks to maintain higher quality liquid assets, which could strain smaller players.

Looking ahead, AU SFB's ability to navigate these challenges will be crucial. The bank plans to raise Rs 1,000 crore through qualified institutional placements (QIPs) in the coming months to strengthen its capital base, which currently boasts a healthy capital adequacy ratio (CAR) of 22%. This infusion could support expansion into new geographies like eastern India, where demand for microfinance is high.

Investors are advised to monitor upcoming quarterly results, expected in late July, for clearer insights into deposit trends and the initial outcomes of the LIC partnership. If AU SFB can demonstrate improved metrics, the current dip might present a buying opportunity. Conversely, persistent weaknesses could lead to further downgrades and price corrections.

In summary, the Kotak downgrade has spotlighted AU Small Finance Bank's vulnerabilities in deposit growth, even as strategic moves like the LIC tie-up offer hope for diversification. As the banking sector evolves with digital disruptions and regulatory changes, AU SFB's resilience will be tested, influencing not just its shareholders but the broader ecosystem of small finance banks in India. The coming months will reveal whether this is a temporary setback or a sign of deeper structural issues. (Word count: 1,028)

Read the Full Business Today Article at:
[ https://www.businesstoday.in/markets/stocks/story/au-small-finance-bank-shares-fall-kotak-downgrade-deposit-growth-lic-partnership-484454-2025-07-14 ]