Banking Sector Review

Banking Sector Review

Banking stocks have been in limelight in last quarter or so for right reasons as it has been one of the top performing sectors in Indian equity market in quarter ending March’14. Price appreciation in banking stocks is aptly backed by improving fundamentals at both macro and micro level on the one hand and relatively cheap valuation on the other hand.

Some key economic indicators that moved in favor of banking stocks were:

  • Composite CPI fell from a high of 11.2% in November ‘13 to 8.1% in February’14
  •  India has witnessed the sharpest improvement in current account deficit (from -5% of GDP in Jun’13 to -0.9% in Dec’13) among emerging economies.
  • India’s FX reserves have also posted the highest accretion (8%) since Sep’13
  • INR has appreciated 12% since 4 Sep’13

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Clearly equity investors were getting a sense that the economy is on the way to be out of woods and a gradual revival is in sight.

chart1

Some key announcements from the RBI also worked in favor of the banking stocks:

  • The RBI extended the deadline for full implementation of Basel III by a year to march 2019. Capital conservation buffer will now kick in a year later in March 2016. This will provide some interim relief to banks with capital constraints (especially public sector banks such as Union bank, Canara Bank, etc.).
  •  Hiving off of bad loans to ARC (Asset Reconstruction Company) will boost liquidity for concerned banks.  Additionally, sale to ARCs by few banks may keep headline asset quality numbers in check.

Additionally, the RBI issued two new banking licenses (among 25 players who applied for licenses) to IDFC and Bandhan Financial Services. Moreover, the RBI in its recent monetary policy recommended that banks should not levy penal charges for non-maintenance of minimum balance in ordinary savings bank account and inoperative accounts. Analysts suggest that non-levy of penal charges for minimum balance maintenance will not have significant earnings impact.

chart2From valuation perspective, banking stocks had been hammered more than required in the last couple of years. Actually many of the banks, especially public sector names, were trading as low as 50% discount to book value. Amidst this scenario, foreign institutional investors betting big on economic revival and thereby a favorable interest rate scenario started looking at banking stocks

Some leading brokerage  house such as the Goldman Sachs also upgraded PSU Banks stating that NPL level and stressed assets will gradually decline as economic conditions improve; the potential for policy action after the general election might improve the operating environment for banks, according to them.

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Decision of the mutual fund companies to increase bets on banks acted as a catalyst for appreciation in banking stocks. The Economic Times reported that “Top mutual funds mounted bets on banks in March and cut their holdings in information technology (IT) stocks as investors worried about the impact of advancing rupee on exporters. Fund managers said valuations of IT stocks were expensive considering the stronger Indian currency, prompting them to shift a portion of their money to battered bank stocks”.

Going forward earning result for 4Q’14 or FY14 will provide direction for banking stocks at least in short term.

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