The mystery stock from Jaipur leading India's bank index in 2025

Mint

2 days ago

New Delhi: 2 May 2016
Stamford Bridge football stadium, London.
As the final whistle blew on a fiery draw between Chelsea and Tottenham Hotspur, a raucous cheer erupted from an unlikely corner of the crowd. It wasn't the match result they were celebrating, but one of the most astonishing moments in modern sporting history—lowly Leicester City, which had narrowly staved off relegation in the previous season, was crowned Premier League champions for the first time in their 132-year history.
Leicester City had earned a promotion to the top tier in English football just two years earlier. At the beginning of the 2015-16 season, bookmakers had given the team odds of 5,000-1 for winning the title. For context, the odds of Elvis Presley being found alive was 2000-1. In other words, Leicester's chances of being crowned the champions of English football were lower than Elvis being found alive.
And yet, the unthinkable had happened. The unheralded team with a modest wage bill had trumped the Premier League powerhouses like Manchester City, Manchester United, Arsenal and Chelsea.
Rank outsiders emerging on top always leaves behind a trail of heartbreak, euphoria and bewilderment. Not to mention a scramble for explanations.
Something similar is underway on Dalal Street, where the unlikeliest of candidates has emerged as Nifty Bank Index's top performer this year—AU Small Finance Bank. It not only has the smallest weightage in the grouping but also the only one without a universal banking licence. As yet.
But as the lender's June quarter (Q1) show suggests, while scale is not a prerequisite for strong execution, the market may well be rewarding promise more than performance at this juncture.
The Edge
Comparison may be the thief of joy, but in the markets at least, It is often the starting point of conviction. AU Small Finance Bank posted a decent showing in Q1FY26, with net profit climbing 16% on-year to ₹581 crore on the back of an 18% jump in net total income. But it is only when set against the backdrop of the sector's leaders that its outperformance in many critical areas stands out.
Take credit growth, for example.
At a time when the sector is facing strong headwinds in the form of slowing credit expansion, the Jaipur-based company posted a loan growth of 18% over the year-ago quarter. To put things in perspective, the country's largest private sector lender HDFC Bank's gross advances inched up 6.7% in Q1. While this is quite understandable, given that it has been consciously moderating loan growth to bring down its credit-deposit (CD) ratio closer to levels before its merger with HDFC, even ICICI Bank, arguably the Street's favourite private sector lender currently, reported domestic credit growth of 12%.
AU Small Finance Bank's management has reiterated its target of achieving loan growth of 2 to 2.5-times the nominal GDP growth.
System credit has been sputtering since the second half of FY25 amid macroeconomic headwinds and a marked slowdown in domestic consumption. While FY26 is showing incipient signs of a revival in consumption, credit demand remains muted. According to data from the Reserve Bank of India (RBI), system credit growth softened from 14-16% in the year-ago quarter to 11-13% in second half of FY25, and further to about 9-11% in Q1 this year.
Similar is the case with deposits.
Banks are finding it tough to mobilise deposits in an environment of low interest rates, with investors channeling their savings towards other avenues like equity markets. System deposit growth slowed to 10.6% in FY25 from 13% in the previous financial year.
In this context, AU Small Finance Bank's deposit growth of 31% in Q1, compared to the year-ago period, stands out. More so, given the 16.2% deposit growth of HDFC Bank and 12.8% of ICICI Bank.
That said, comparing a small finance bank with the sectoral behemoths would elicit a derisive snort from statistical puritans. After all, the small bank's deposit base of ₹1.28 trillion operates in a different mathematical universe when compared to HDFC Bank's ₹27.64 trillion and ICICI Bank's ₹16.08 trillion.
But even under-the-hood metrics show an edge for AU Small Finance Bank. The firm's net interest margin (NIM)—a key measure of banks' core profitability—is higher than the industry stalwarts. NIM is a measure of the difference between the interest earned by a bank on its loans and securities and what it pays out to depositors.
Similarly, its pre-provision operating profit (PPoP), which is a key financial metric representing a bank's core operating performance before accounting for provisions for potential loan losses, surged 38% on-year, compared to 11% for ICICI Bank.
The small bank's earnings per share (EPS) growth— arguably the most important yardstick from a stock market perspective—stood at 15.2% in Q1, compared to 11.4% for HDFC Bank and 13.8% for ICICI Bank.
Words of Caution
However, this is not to suggest that the Q1 numbers were an all-round success. For instance, NIMs dropped to 5.4% from 6% in the corresponding quarter of the previous financial year, in tandem with other lenders grappling with the challenge of declining interest rates on loans and stickier rates on deposits.
More worryingly, AU Small Finance Bank's asset quality has shown a marked deterioration, albeit in a seasonally weak quarter. Gross non-performing assets (GNPA) ratio rose to 2.47% in Q1 FY26 compared to 1.78% in the year-ago quarter, while net NPA ratio climbed to 0.88% from 0.63% in the same period.
The micro finance segment (MFI) is also seeing stress, with GNPA ratio at 4.1%.
'The projected credit cost for MFI in FY26 has been revised upward, with the segment now expected to incur a 5% credit cost compared to the earlier guidance of 3%," Centrum Institutional Equities stated in a note.
Apart from lower collection efficiency in the MFI segment, the management has also flagged concerns in the mortgage book in the southern states (mostly belonging to Fincare Small Finance Bank, which was merged into AU Small Finance Bank in April 2024), as well as some stress in its credit cards portfolio.
'On unsecured retail loans, recovery in asset quality seems to be delayed than earlier expectations, but we seem to have better visibility on 2H FY26. Management has highlighted stress in certain pockets of secured retail businesses (mortgages in southern India and small commercial vehicles); we are unsure about the eventual credit cost outcome of these issues," analysts at Kotak Institutional Equities noted. 'We are unsure if asset quality is at its best for the bank. We are also unsure if the broader operating environment is favourable enough for the bank to deliver strong loan growth," it added.
While some analyst commentary is understandably cautious, the stock's chart-topping 30% rally this year so far exhibits a peculiarity of the market—it is a forward-looking mechanism, which assigns a greater weightage to what a company might become than what it is currently.
And this is where AU Small Finance Bank might be punching above its weight.
God of Small Things
Small Finance Banks (SFBs) were introduced in India in 2014 as a distinct class of lenders aimed at deepening financial inclusion. Unlike payments banks, SFBs are permitted to both accept deposits and offer loans, with a focus on serving segments traditionally under-represented in formal banking, like small and marginal farmers, micro and small enterprises (MSMEs), and low-income households.
As per rules, SFBs need to keep at least 75% of their loans below ₹25 lakh and at least 25% of their branches must be in rural areas that lack banking services. This is in contrast to universal banks, which have no such restrictions, besides ensuring that 40% of their loans are given to priority sectors like agriculture, MSME etc.
Universal banks cater to a broader range of customers, including large corporates and government entities. They offer a wide range of services like investment banking, corporate banking, among others. For entities engaged in the lending business, securing an universal banking licence is seen as the pinnacle of financial evolution, marking their elevation from niche operations to a coveted seat at the big table.
In August 2016, the RBI introduced the 'on tap' licensing policy for universal banks, allowing eligible entities like SFBs to apply for a banking licence at any time. The applicants have to meet a number of stringent criteria, including those related to minimum net worth, operational parameters, capital adequacy, NPA levels, board structure and others.
AU Small Finance Bank, which began operations as AU Financiers in Jaipur in 1996 and became an SFB in 2017, applied for a universal banking licence on 3 September last year. The stock, which was trading in the range of around ₹600- ₹640 in August 2024, surged to ₹750 levels in September after its application was filed, before succumbing to profit booking.
After a quiet few months, the counter resumed its upward trajectory April 2025 onwards. A rule of thumb in equities is that markets move first, news follows later. Is this what is transpiring in the stock currently, especially given that the positives and negatives seem to be evenly matched in its quarterly numbers?
Licence to rally
We believe the rally is largely driven by optimism around its application for a universal banking licence," Asutosh Mishra, head of research at Ashika Institutional Equity, told Mint. 'If approved, the licence would mark a strategic milestone—enabling the bank to expand its product offerings, diversify its balance sheet, and significantly lower its cost of funds," he added.
The market, therefore, is pricing in the transformational potential of AU Small Finance Bank becoming a full-service bank.
The bank declined to comment for this story. However, at its earnings call earlier this month, Sanjay Agarwal, the company's founder, managing director and chief executive officer, indicated that a decision on its licence is expected soon. 'I believe that this year, the decision should be made. I'm not sure what decision…but it's already 10 months since our application," he told analysts.
He also exuded confidence about the company's margin pressure stabilising from Q3 onwards, given that around two-thirds of its portfolio is fixed rate. Stress in the MFI and credit cards segments could ease from next year, the founder added.
Interestingly, another universal banking licence contender, Ujjivan SFB, which submitted its application in February 2025, too is seeing a similar rally on the bourses, with its stock surging over 35% year-to-date.
Second-guessing the regulator is a dangerous game, but at an event in the national capital last week, RBI governor Sanjay Malhotra reiterated the central bank's objection to allowing corporates obtain banking licences, citing 'conflict of interest".
Market watchers say this increases the chances of standalone SFBs obtaining the coveted banking licence. However, it is important to note that no licenses have been issued yet since RBI announced the 'on tap' licensing policy in August 2016. The last time universal banking permits were issued was in 2015, when IDFC and Bandhan Bank received the go ahead.
'Promising franchise'
Some analysts also maintain that the investment thesis for smaller lenders goes beyond whether they are able to secure a banking licence or not.
'We believe small and mid-sized banks are well-positioned to outperform, especially in the evolving interest rate environment," Ashika Institutional Equity's Mishra said. 'These banks typically have a higher reliance on term deposits, and with RBI's recent pivot towards easing—through both rate cuts and liquidity infusion—they stand to benefit more meaningfully from lower funding costs as their deposit base gets repriced. While stock selection remains important, the macro tailwinds clearly favour nimble, deposit-sensitive lenders in this phase," he added.
However, there is no denying the anticipation which has built up in counters like AU Small Finance Bank.
Motilal Oswal expects the bank to maintain its growth leadership in the sector. That said, the domestic brokerage house has slashed its earnings estimate by 0.7% and 3.8% for FY26 and FY27, respectively.
'After a sharp recent outperformance, we see limited near-term catalysts for the stock. However, we believe that AU Small Finance Bank has the potential to emerge as a promising franchise over the medium term, especially after it secures the universal bank license," it stated in a note.
Short-term exuberance may be enough to lift a stock, but only long-term execution cements a company's place at the table. Banking licence or not, this is what will determine its next phase of growth.