Tough Road ahead for the Banking Sector

Tough Road ahead for the Banking Sector

Banking sector was in doldrums even before the pandemic hit the markets. Geyatee Deshpande takes stock of the current situation in the banking sector and advises caution before investing in any financial stock while also highlighting the factors one should look at before choosing banking and financial stocks for investments. 



Globally, the banking sector was going through a churn even before the pandemic arrived and changed it forever. Before the pandemic the global retail banking industry was seen struggling with low interest rates, closing bank branches, rising risk of small and medium enterprise (SME) bankruptcies, consumer defaults and eroding market share. “Similar to the global banking sector, the Indian banking sector had been getting crippled with various challenges even before the pandemic and according to me, all that the pandemic has done to the sector is worsen its condition even more,” says Mr Pravin Shah, who has been investing in banking stocks for around 10 years now.

Back then, banking stocks witnessed increased volatility since January 2020. In the calendar year 2020, Bankex actually declined by 1.98 per cent and fell a step back compared to Sensex during the recovery period. This is not only the case in domestic markets but also in the global markets. As banking stocks took huge blows during the spread of the corona virus, during the period December 2019 and April 2020, many banks witnessed significant slumps. European banks felt the blow too, and it reflected in the Euro STOXX banks. It displayed a major decline of 40.18 per cent during the period while STOXX North America 600 banks’ index declined by 31.23 per cent. The STOXX Asia-Pacific 600 banks’ index fell by 26.09 per cent during that time.

But now it has been more than a year since the pandemic, and according to experts it is now that the banking sector will truly reflect the true impact of the pandemic and the way forward. Looking back, the Indian financial system consists of a number of cooperative banks, domestic financing institutions, scheduled commercial banks, regional rural banks, pre-reform traditional private sector banks, tech-savvy private banks and foreign banks. And the recent entries in the sector are small finance banks, payment banks and large number of mobile financial applications.

While such a potpourri exists, suggested reforms as below by committees allow for the banking sector to remain sustainable:

Merging of banks and closing weak and unviable ones
Having two or three banks to serve as international banks and a larger number of domestic banks, including RRBs
Integrating NBFC activities with banks
Reviewing major banking laws.

Crisis and Support

Yet, when partly implemented, the banking sector is still in the crutches of risky debts with the profitability of many banks being affected. Even though banks including PSBs have been merged, weak and unviable banks have not been closed. The Reserve Bank of India (RBI) has already warned of a looming credit crisis, projecting that the gross NPA (non-performing assets or bad loans) ratio for Indian commercial banks would increase from 7.5 per cent in September 2020 to more than 10 per cent in September 2021. Additional worsening of macroeconomic conditions will further pressurize banks as increasing NPAs will weaken banks since they will have to make provisions for the expected defaults. This will further lead to reduction in the capital available for new loans and making bankers more wary of lending, thus limiting the credit available to businesses to fund their activities. Moreover, it can also raise the cost of credit, thereby creating a hurdle for growth.

Amidst such weak economic conditions, the government and the RBI continue to lend their support to the banking sector. While a slew of measures implemented to alleviate the stress on the banking sector, quite a lot of capital has also been infused. The centre had infused around Rs 90,000 crore into public sector banks in the year 2017-18, followed by Rs 1.06 lakh crore in the year 2018-19. In the year 2019-20, it proposed Rs 70,000 crore capital infusion and had also approved of another Rs 20,000 crore in September 2020. For the year 2021-22, a further capital infusion of around Rs 20,000 crore into public sector banks is expected. Additionally, during the Union Budget announcement this year, Finance Minister Nirmala Sitharaman announced setting up of a bad bank to move the bad loans of the public sector banks (PSBs) to this bad bank and thereby clean up their balance-sheets.

Yet with such provisions being made, a year after the pandemic, grey clouds still continue to loom over the Indian banking sector. Recently, ratings agency Fitch Rating said that it expects a moderately worse sector outlook for Indian banks for FY22, based on muted expectations for new business and revenue generation and deteriorating asset quality. Banks reported lower impaired loans and improved profitability for the nine months ended December 2020 due to various forbearance measures and continued large write-offs. But still, shocks to small business coupled with high unemployment and declining private consumption will reflect its impact on the banks’ balance-sheet by end of FY22.

The increase in NPAs is truly a concern for the banking sector that has rung alarm bells. A major risk of the banking sector stress is that it will leave millions of households and small businesses cut off from credit they need. Banks have started assessing that a number of companies they have lent to will not be in a position to service their debts and in such case they will have to treat these loans as NPAs. Further, banks need to make provisions for these NPAs thereby reducing investible capital resulting into a capital crunch. Particularly, government owned banks have remained more risk-averse than in prior years, which was reflected in their weak credit growth.

These banks have limited core capital buffers in event of further asset stress. If stressed loans are not to be classified as NPAs, another option is for them to be restructured. Public sector banks will be the most hit with this approach as the private sector banks will be able to proactively analyse stressed assets and will ease out of positions where the defaults are likely to happen. Hence, private banks are better placed in terms of handling stress to have better profitability and contingent reserves and capitalization. Defying these practical conditions in the banking sector, banking stocks have rewarded investors with high returns recently, with the Bankex outperforming domestic benchmark indices on YTD basis and in a timeframe of one year as well. Bankex gained by 6.41 per cent on YTD basis while Sensex was up by 4.74 per cent for the same period of time as seen in the table.

While the pandemic led to stocks grappling in the downward spiral in 2020, later on stocks joined the market rally during the post pandemic recovery period aided by strong Union Budget sentiments and positive sector related news. The table below highlights a list of stocks that have performed very well on YTD basis.

Even as gains in banking stock have been bullish, experts have a contradictory opinion on the outlook of the banking sector. Till now banking stock were seen participating in a broad-based market rally. Moreover, as markets start to come out of their bullish nature witnessing corrections, the real confidence of investors in the sector will be reflected depending on the sectors’ growth trend and sustainable footing. Looking at the grim underlining in the banking sector, it is best for investors to enjoy partially booked profits from the recent rallies in banking stocks and remain extremely cautious while investing in the future at least till the true state of impact on banking sector is known.

Shah also states that while in recent times banking stocks have enjoyed news based rallies, the real catch in benefitting from long-term gains in banking stocks is to keep a check on the health of the bank you are invested in. Investors must keep a look at the bank’s liabilities and asset trend, trends in retail banking, NPA trends and the performance of its subsidiaries. While tracking a bank’s asset quality is important, an investor must be aware if the bank is based in an environment wherein it can consider aligning with the changing consumer needs such as of digitization and easy day-to-day banking. Compared to PSBs, private sector banks are generally more capable of adapting to faster changing consumer needs, improving operational efficiency, diversifying and also improving margins by cutting costs. Even if the macro view of banking stocks may look tempting, the bird’s eye view of the reality of the banking sector should guide investors wishing to bet on banking stocks to remain cautious and stock-specific

Expert Opinion Bhagyashree Sawant, Ganesh Angaj, Research, Khandwala Securities

Both PSU and private banks witnessed a deep dive during December 2019 as a reaction to the advent of the corona virus. However, private banking index hit its lowest point during March 2020 as a repercussion, consolidated till May 2020 followed by a sharp recovery hitting all-time high in February 2021. On the contrary, PSU Banking index extended its losses till May 2020, in which it also broke below its multi-year low of 1900, followed by a sharp bounce nearing its November 2019 resistance.

Now PSU Bank index has given a bottom reversal while Private Bank gave a multi-year breakout giving all time high to continue the bullish pattern. The month of March was a halt though. The upside could be a pullback or a bullish reversal for PSU Bank index. Hence, 1900-1850 can be observed as the support for Nifty PSU Bank index. On the other hand, the March correction could be a drawback of the breakout or a bearish reversal. Hence, closing above 18,000 for March 2021 is important.

PSU Banks

SBI Bank : After hitting all-time high in mid-February 2021, the stock of SBI Bank formed head and shoulders pattern at the top with a neckline at 385. Likely the stock gave a breakdown and hit the target near 350-345. However, considering longterm, it was a drawback after a multi-year breakout at 352. Hence, monthly closing above 362 may give a bounce-back push to the stock. For now, avoid.

Bank of Baroda : The stock of Bank of Baroda broke its higher top higher bottom pattern during mid-March 2021 at 76.85. Now, the stock has taken a trendline support at 68 on the daily timeframe. Hence, if 68 is maintained, we may see a pullback up to 75.60 followed by 4 points resistance at every uptick. If bought, it can hold with a stop loss of below 68; otherwise enter above 76 on closing.

Private Banks

HDFC Bank : The stock of HDFC Bank gave a breakout of an upward sloping trendline on the daily timeframe. However, the stock witnessed correction after hitting triple top in the zone of 1,630-1,640. The stock has bounced back again from the trendline level and hence can be held with a stop loss of below 1,450. Oscilattors too have bounced back from the multiple support which was just above the oversold zone.

ICICI Bank : The bank had given multiple resistance breakout at 550 levels during a sharp upside on February 1. The stock corrected from all-time high at 679 near to the multiple resistance level which also acted as an upward sloping trendline support. It witnessed a Doji on the day of support with confirmation which suggests some more upside.

Caution: The upside could be a pullback or a proper bullish continuation as the oscillators have given a bounce-back but volumes are yet to support the upside.

Check Your Bank’s Health

To check if your bank is safe enough for investing, an investor can consider looking at points such as:

NPAs: NPAs indicate how much of a bank’s loans are in danger of not being repaid. A very high gross NPA ratio means the bank’s asset quality is in very poor shape. While banks provide for some loans going bad, the net NPA is that portion of bad loans which has not been provided for in the books and thus the net NPA is a better indicator of the health of the bank.

Provisioning Coverage Ratio: Banks usually set aside a portion of their profits as a provision against bad loans and hence a high PCR ratio, ideally above 70 per cent, means most asset quality issues have been taken care of and the bank is not vulnerable.

Capital Adequacy Ratio and Current and Savings Account Ratio: CAR is the ratio of a bank’s capital in relation to its risk weighted assets and current liabilities and is a measure of a bank’s ability to meet its obligations. CASA is the proportion of current account and savings account deposits in the total deposits of the bank. A high CAR means the bank can absorb losses without diluting capital whereas low CASA ratio means the bank relies heavily on costlier wholesale funding, which can hurt its margins.

Credit-Deposit Ratio: This ratio shows how much a bank lends out of its deposits or how much of its core funds are used for lending and hence a high credit-deposit ratio suggests an overstretched balance-sheet, and may also hint at capital adequacy issues.

Net Interest Margin: Net interest margin is the difference between interest earned by a bank on loans and the interest it pays on deposits. So accordingly, NIM will be high for banks with higher low-cost deposits or high lending rates. It is generally though that low NIM and high NPA is a bad combination. 

 

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