Banking Special : Banks To Participate In Market Rally In 2021
Banks have single-handedly pushed the markets to record highs in November after a period of underperformance and consolidation. It will be extremely interesting to see if they continue to contribute constructively in the expected market rally in 2021. Ganesh Vaybase analyses the historical performance of banks while also sharing an outlook on one of the most important sectors in Indian economy while Vinayak Gangule shares the technical outlook on Bank Nifty
The global risk mode is expected to be on display in 2021 which suggests equity as an asset class may outperform yet again. The race to outperform the benchmark index is always an interesting one. Pharmaceutical and IT stocks dominated the markets in 2020 while banks and financials struggled owing to the worsening economic scenario. After witnessing this upheaval in 2020 and taking a lesson from yet another market crash in this year, market participants are betting on a V-shaped recovery globally owing to continued policy support and overwhelming liquidity infusion into the financial system.
There is a good chance that we may see a synchronous rally in global equity with a chance for emerging markets to outperform the developed markets by a slight margin. India within the emerging markets could attract disproportionate equity allocation owing to rapid recovery and macro fundamentals. The banking sector will play a crucial role in 2021 as the economy recovers steadily. In fact, banking and financials will be one of the biggest beneficiaries of a recovery in the economy as things normalise and credit expands. Banks and the NBFCs were the most battered sectors in 2020.
These are the same sectors that will show the maximum rebound in 2021. The recovery in the sector is already reflected by the steady recovery in the stock prices of banks. In the past three years, banks as reflected in the performance of the Bankex have been underperforming the Sensex. However, when we consider a period of over 10 years we find the Bankex outperforming the Sensex.
Trends in Banking
The global banking system is more resilient, profitable and bigger now than it was a decade ago. Same is the case of the Indian banking sector. Overall, digitization has led to costcutting and operational efficiencies. After multiple shocks aced in the economy and the banking system there is visible mark of resilience in the system even as the relationships between banks, financial technology (fintech) and big technology (bigtech) are evolving rapidly. More and more banks are seen collaborating with fintechs to make easy the transfer transactions at banks online. A visible change is the way banks see fintechs as collaborators rather than scrappy adversaries.
As technology has become key in helping banks with innovative processes there is an increasing convergence between bigtechs and the banking industry. Banks need bigtech companies and in many ways bigtechs need banks as a steady revenue source. Meanwhile, digital spend is increasing, mobile banking is gaining ground and social media banking is the latest from the banking industry in India. Smart banks know how to use technology in improving the overall customer experience of banking online as an increasing number of customers prefer digital banking. Some of the leading private banks are experimenting with ‘virtual relationship management’ where technology comes alive with a human touch. A clear trend in the banking industry is to focus on digital banking and improve operational excellence and innovate in order to improve the customer experience of banking.
SBI’s wealth management business has shown exponential growth in terms of client acquisition and assets under management during the financial year. The number of clients increased by 2.4 times from 55,502 in March 2019 to 1,32,354 in March 2020 while the AUM grew by 3.6 times, reaching Rs 1,09,061 crore against Rs 30,270 crore during the period.
While the focus is on digital banking and expanding franchise network in semi-urban and rural areas most of the banks have been busy raising capital to be prepared for the rising NPA situation owing to the pandemic. Banks were already struggling with rising corporate debt burdens before the pandemic hit the markets in the worst way possible. The pandemic led to falling prices in assets and elevated market volatility which worsened the financial stability or banks in general. The aggregate deposit growth remained in the range of 9 per cent to 11 per cent before ending at 7.9 per cent in FY20.
As per data on sector-wise deployment of credit released by the RBI for March 27, 2020, retail loans grew by 15.7 per cent, credit to services sector by 8.5 per cent, credit to industry by 1.4 per cent and credit to agriculture sector by 5.2 per cent.
Retail loans as a proportion of total loans increased from 60.1 per cent as of March 31, 2019 to 63.2 per cent as of March 31, 2020. Including non-fund based outstanding, the proportion of retail portfolio increased from 46.9 per cent on March 31, 2019 to 53.3 per cent on March 31, 2020.
This low growth can be attributed to the previous year’s high base and the pandemic. The credit off-take also took a major hit during 2019-20. Credit growth was recorded at 6.1 per cent which was less than half the growth of 13.3 per cent in 2018-19 due to low momentum and unfavourable base effects. This slowdown in credit growth was spread across all banks and was especially visible in private sector banks. In the banking system incremental credit has increased only in agriculture and allied sectors while all the other sectors have shown deceleration.
Credit to the industry declined to 1.4 per cent in FY20 from 6.9 per cent in FY19 while the credit to services was recorded at 8.5 per cent in FY20 which in FY19 stood at 17.8 per cent. Personal loans declined marginally to 15.7 per cent in FY20 from 16.4 per cent in FY19 even as the credit to MSME and NBFC increased substantially due to enhanced support by banks in the form of increase in working capital limits. In FY20 the monetary policy transmission to the banks’ term deposits and lending interest rates improved. There have aggressive rate cuts in deposit rates as well across the board.
Banking Industry Outlook
The last fiscal year started with a lot of promise for the banking sector with steady progress in resolution of the stressed assets. The Union Budget was also supportive of the banking sector and overall growth; however, the outlook got murkier for the banks in the fourth quarter with the pandemic hitting the markets. The outlook for banks needs a careful revision with the lockdown measures having led to considerable loss of income in the poor sections of society. There is a chance that the slippages will increase going forward and the worst in terms of stressed assets is yet to be seen.
The outlook on banks is conditional in terms of how well the economy picks up and how well all the other sectors start recovering. Banks will reflect the strength on ground. So far, from the earnings season it is easy to conclude that the situation on ground is not as bad or as grim as was initially thought. There is stress in the system no doubt, but the situation is improving globally and with fiscal stimulus at play the outlook on banks also depends on how well the fiscal stimulus manages to revive various industries in India. A V-shaped recovery in economy augurs well for the banking industry.
Bank Nifty
Bank Nifty, the banking benchmark index, registered its all-time high in early January 2020. Thereafter, the index witnessed fierce sell-off in the next 13 weeks. The index has plummeted nearly 51 per cent from the high of 32,613.10. The correction halted near 61.8 per cent Fibonacci retracement level of its prior upward move (8,366.75-32,613.10). After registering a low of 16,116.25, the index maintained its rhythm of higher tops and higher bottoms and during this process it surpassed the resistance one after the other in the form of 200-day SMA and the 61.8 per cent retracement level of its prior downward move (32,613.10- 16,116.25).
Currently, the index is trading above its 200-DMA since the last 21 trading sessions by almost 24.49 per cent. Barring Bank of Baroda and Punjab National Bank, all the constituents of Bank Nifty are trading above their 200- DMA. Among the momentum indicators, the 14-period weekly RSI is currently quoting at 66.97 and it is in a rising trajectory. The momentum indicator MACD has crossed above the signal line, which has resulted in the histogram turning positive on the weekly chart.
One interesting takeaway for the bulls is that on November 4, 2020 the Bank Nifty index formed a ‘golden crossover’ pattern, which is considered as a long-term bullish sign. In technical parlance, the golden crossover occurs when a short-term, 50-day simple moving average crosses above the long-term, 200-day simple moving average on any index or stock. Since 2006, there have been 11 instances when a golden crossover has occurred in Bank Nifty index within which in six occurrences it provided positive returns while five turned into losing trades.
Currently, the 50-DMA of the Nifty is placed at 23,844.70 and the 200-DMA is placed at 22,968.75. Going ahead, the immediate resistance is at the 29,200 level and any sustainable move above 29,200 is likely to open up the gates for a further rally towards the prior high level of 32,613. On the downside, the zone of 25,600-25,400 will act as major support for the index as it is the confluence of an upward sloping trendline support formed by connecting swing lows since September 2020 and the 34-day EMA level.
Conclusion
On the face of it the business of banking looks simple and easy to understand. The devil lies in the details. It is not an easy task to understand and predict which strategy may provide advantage to which bank in order to gain market share. Ultimately the bank that is able to steadily gain market share is the one where investors would create wealth for themselves in the long term. Even though the PSU banks may look attractive from value point of view, the momentum is clearly in favour of private banks. This is because they are able to grab market share from their PSU counterparts, consistently.
On all parameters the performance of private banks is superior and hence investors can have a higher weightage in favour of private banks in a diversified portfolio as compared to PSU banks. Without differentiating between the private banks PSU banks, a bank should be chosen on the basis of whether it continues to innovate, is customer-centric, displays operational excellence, maintains product leadership, has robust asset quality, maintains a strong franchise network, keeps digitizing to improve customer experience and enhances efficiencies, enables differentiated experiences through applications, APIs and analytics, and above all, is profitable while doing all it can to increase its market share.
Select large private banks and SBI amongst the PSU pack have been able to improvise their processes and digitize operations to an extent that these adaptations are able to not only minimise costs for the banks but also provide an edge in acquiring customers. Banks have been underperforming the markets if we consider the past three years’ performance. However, the sector is strategically important for an aspiring nation such as India and hence it is inevitable to have exposure to the sector if one wants to participate in the India growth story. While doing so, investors have to simply stay focused on the consistent performers and remain aware about the business environment these banks operate in.
Investors ought to keep a tab on liabilities and assets trend, trends in retail banking, NPA trends and the performance of the subsidiaries. For example, the income from subsidiaries jumped by more than 10 per cent in FY20 when compared to FY19 for ICICI Bank. Such a superlative performance adds to the bottom-line and thus can push stock prices higher. While tracking asset quality is important, an eye on the steps taken to increase the network of franchises, especially in semi-urban and rural areas, is the key in identifying winners in the banking space. HDFC Bank is one such winner in the banking space which has been able to increase its franchise network in rural areas optimally.
Semi-urban and rural geographies have been displaying good growth traction lately and the presence in such high-growth areas is always profitable for banks. Those banks with higher percentage of retail lending are seen to be faring better and hence investors can scan for entities with better market share in the retail lending space. While on the business side it may be easy to spot the trends in assets and liabilities, a peep into the enterprise risk management of the banks will go a long way in identifying the future winners. Overall, as the economy recovers, the banking sector can be expected to recover faster. However, it will be a mistake to conclude that all banks will recover steadily.
One will have to be extremely stock-specific while investing in banks. While the macro picture will always highlight promising aspects for the sector merely because of the sheer size of the industry, one must not forget that the banking sector is one of the most vulnerable to any kind of disruption. Technology is very important for banking and hence only those banks that are keen to adopt cutting-edge technology will have a chance to survive in the long term. Any bank that fails to adopt new technology that can improve operational efficiency and improve margins by cutting costs may stand to lose market share.
Meanwhile, as the interest rates are at all-time lows, the net interest income for banks may take a hit. The margin squeeze could be higher for PSU banks. Banks will have to generate higher income from fee-based products in the future to remain profitable. Wealth management could be one of the most important services provided by banks, which can also be the most profitable. SBI is one such example where there is significant growth visible in the wealth management business segment.
To take a bird’s eye view, the outlook remains good for the banking sector as the economic activity improves. The outlook for private banks that use high-end technology and are customer-centric is bullish. Investors may continue to bet on banks within the portfolio context. However, a bottom-up approach of investing is essential while doing so since not all banks will be able to survive the unprecedented volatility in the economy.
Methodology
The banks are ranked on comprehensive financial parameters. The financial performances are grouped into four major categories namely size, growth, efficiency and asset quality. Again these major categories are subdivided into different financial parameters.
While considering size we subdivided it into the size of total assets of the bank, total income, operating profit and net profit. For growth, we have considered CAGR in net interest income, operating profit, net profit and balance sheet size of last 2 years ending FY20. For the most efficient category, we have considered total advance to deposit ratio, profit per employee business per employee and Return on Asset (RoA) for FY20. For asset quality, we have taken Net NPA as % to Net Advances (FY20). All the individual parameters are given appropriate weightage to arrive at the final ranking.
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