Dear Reader,
Around a month ago, we had asked a question: Is the banking party finally over? Lip-smacking return ratios, ultra-low bad loan pile and fattened net interest margins could finally be at an inflection point, we had argued. Indeed, the underwhelming performance of banking stocks relative to the broader market gave conviction to this idea of a finale.
Fast forward to today, the party seems to have gotten extended, much to the delight of investors. Nifty Bank index has surged about 6 percent so far this month, leaving behind the broader Nifty with a 4 percent gain.
But if we parse through data that show how the banking sector has fared, nothing much has changed in the past three months. The banking sector continues to struggle with deposit growth, although some signs of relief are beginning to emerge. Absolute deposit accretion in the first fortnight of June was higher than absolute expansion in credit. Even so, there remains a wide wedge between credit and deposit growth, and banks would face pressure on their margins in FY25. Our Chart of the Day details how return ratios of banks may come under duress this year because of the expected margin compression.
Of course, the pain would be mild and return on assets and return on equity would be superior to previous years. Analysts have continued to maintain that banking valuations may be nearing a peak and the sharpened regulatory oversight and punitive actions must keep investors cautious.
What has changed for investors to load up on banking shares this month?
A lot has to do with the outcome of national elections on June 4. A coalition government was unexpected, and investors are dialling back on the reform aggression they earlier expected from the centre. Coalitions mean delays in decisions and lack of resolve in taking hard decisions. Simply put, the hopes of privatisation of public sector banks and reduction in the grip of the government are now gone. That has now been replaced with concerns that the government could use its lenders to further some of its populist schemes. The discomforting dread of loan melas and waivers has entered investors’ minds. Ergo, public sector banks that had powered the banking stock rally in the previous months have now been pushed back. Despite this change, the public banks are still loved because where else can the government push its capex thrust?
Shares of private lenders are now at the forefront with the Nifty Private Bank index surging more than 7 percent so far this month. This compares with a mere 2 percent gain in public sector banks’ stocks. In recent weeks, analysts have reiterated their buy ratings on private sector lenders and put their support behind known blue-chip names such as ICICI Bank and HDFC Bank. Analysts at Emkay Financial Services found that foreign investors were holding on to these banks and others such as IndusInd Bank and Kotak Mahindra Bank. The rationale is this: many of the negatives such as regulatory slaps, uncertainty over top management and deposit struggle are already priced in.
Does this mean that the banking party has still some time left?
The secret to prolonging a party is to keep the entertainment coming and surprising the guests. In that, there is still the Union Budget, the monetary policy and the first quarter earnings, all of which are scheduled next month. That means the banking party could continue and much depends on the entertainment. The Budget could signal whether banks would finally see India’s private sector coming to them for loans to fund capex. Ananya Roy details how investors have high expectations from the Budget, but the reality can disappoint, in her piece here.
The quarterly report card would be selfies that remind investors of the good time they are having. Proofs of margin compression, pressure on profitability and growth would be looked for. If banks show signs of more weakness on margins or growth, investors would talk with their feet.
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