With strong long-term fundamentals, banking sector cannot be completely ignored
That the banking sector has been under a lot of stress in recent times is an understatement. The stagnant economic growth, along with rising debt of both private and public sector banks, have meant performance of most banking stocks have been sluggish at best.
Testimony to this fact is the S&P BSE BANKEX, the banking index, which has clocked a -15.60 per cent returns over 1 year. With bank stocks in the red and feeling the heat with price erosions, here is a look at whether it is a good idea for you to consider investing in bank stocks or should you adopt a change in strategy and avoid the sector all together.
NPAs hurting bank’s balance sheets
Banks including both PSUs and private ones have been facing the heat due to rising bad debt. The rise in non-performing assets or NPAs, especially for public sector banks, has reached a point where it is hurting their overall growth.
Default from both retail loan borrowers and big corporate borrowers have compelled banks to offset the losses in its book of accounts, resulting in a downward trend for the overall growth numbers for the banks.
Inflow of priority capital infusion in public sector banks (PSBs) announced by the finance minister in the annual Budget has brought some respite to the banking sector as a whole, but the long term dynamics remain under stress. Market experts have also suggested that the asset quality and capitalisation of banks are likely to remain under pressure, at least for the next 12 months.
Banks and their 3-point dilemma: Banks cannot stop offering loans to borrowers, but need to check their bad debt and rising NPA numbers. This is creating a 3-point dilemma for them.
1: Banks need to offer more loans to stay profitable: The interest charged by the banks for various loans is one way in which they earn their core revenue base. But the rising NPAs have meant banks have now been very watchful in offering loans. Even in the cases where they are offering loans, banks are making sure the borrower offers some security as collateral with the bank.
The “safety first” approach appears to be a good move, but when the economy is not very buoyant and demand for loans is dropping, such strict scrutiny means borrowers are more likely to explore other loan offers like the ones offered by NBFCs or crowd sourcing for raising finances.
2: Higher the loan, higher is the risk: If the banks look to increase their loan volumes and seek an improvement on its revenue, higher loans will also mean a higher risk of NPAs or loan defaults. Banks therefore have no choice but to walk a thin line between offering adequate loan and keeping their bad debt under check.
3: Strict debt recovery can act as a deterrent for retail borrowers: The actions to be taken against the existing loan defaults is still being discussed by the top management professionals. Banks can make use of debt recovery tribunals, which are now more empowered with autonomous status, to recover their bad debts, but strict loan recovery mechanisms only deters future borrowers.
Considering all these, it’s a tightrope walk for the banks.
Can NBFCs be a preferred alternative?
Even as the above scenario plays out for banks, a recent trend shows of various institutional investors say that NBFCs are definitely the emerging theme in the financial market.
The total market share of NBFCs in credit has registered an increase of 13 per cent in 2015, from the 10 per cent levels in 2005. Various categories of NBFCs, including home finance and consumer finance arms, have been doing good business, generating an increase in both revenues and market share.
While the share of banks in home and housing finance has come down to 62 per cent from the highs of 74 per cent, NBFCs have increased their share from 26 per cent to 38 per cent mark.
It is no surprise then that institutional investors have been investing more in NBFCs instead of banks. Shares of most NBFCs have also done better as compared to banks in recent times, and financial experts believe market consolidation in NBFCs is here to stay.
So should you be buying banking stocks?
The fundamental analysis of making any financial market investment is to buy low and sell high. With sluggish banking stocks, there is a case of entering the banking sector in the stock markets for long term benefits.
The long term growth strategy of the Indian banking sector remains intact as the NPA worry is a short term or medium term roadblock. On the other hand, if you are looking for a short term investment option, NBFCs may be a better idea, replacing the investment in the banking sector.
It is easy to avoid banking sector as a knee jerk reaction to bleeding accounts and rising NPAs, but with strong long-term fundamentals, banking sector cannot be completely ignored, especially by an intelligent investor.
Illustration: Uttam Ghosh/Rediff.com
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