If you want to make a tidy profit by betting on a nimble horse, wouldn't you want to know if it has enough stamina to go the distance or is it likely to lag?
Investors in the banking sector are looking for answers to a similar question. Will the sector continue to perform as well as it has done in the past? For, despite rising interest rates and moderate credit growth, the sector has outperformed its peers.
Since September 2007, the Bank Nifty has delivered a return of 62 per cent compared with 22 per cent by the broader Nifty (see On the Rise). Analysts believe it will do well, though they advise caution on stocks that have delivered returns ranging from 9 per cent to 70 per cent.
For the past couple of quarters, the banking sector has enjoyed an easy monetary policy - low-cost borrowing due to low interest rates and a gain in their investment portfolios because of lower government securities (G-Sec) yields. But with inflation going up, interest rates have begun to rise.
In the past few months, lending and deposit rates have inched up 100-150 basis points (bps). The most recent hike, the fifth this year, of up to 50 bps, was announced by the RBI on 15 September.
However, Rajiv Mehta, assistant vice-president, research, India Infoline, dismisses fears of a slowdown. "The demand for credit has already seen an increase in the past 3-4 months. Also, the impact of rising interest rates will eventually be passed on to customers," he says.
As the cost of deposits goes up, the lending rates will begin to harden. However, there could be a lag between the two, and this is when the net interest margins of banks could come under pressure before the hike is passed on to customers.
Apart from interest rates and liquidity, high valuation and asset quality of banks are other factors to watch out for. Credit quality is another concern as an increase in bad debts is a risk. Mehta recommends stocks with reputed asset quality in terms of lower non-performing loans and adequate capital for growth.
Lessons from the Past
Even during the previous interest rate upswing in 2003, the banking sector generated substantial returns. However, the performance varied across banks. During the early part of the cycle, mid-sized banks were the top performers.
From March 2005, after a one-year lag for deposit and loan re-pricing, the bigger banks began to gain more. Till 2008, the net interest income of private banks had increased 2.4 times, while PSU banks saw an increase of 1.1 times due to declining current account, saving account (CASA) market share.
The market capitalisation for private banks increased by 311 per cent, while for midsized banks, it rose only by 141 per cent. "If interest rates are rising, invest in banks which have bought short-term bonds and have a high CASA ratio," says Vaibhav Agrawal, vice-president, research, Angel Broking.
These banks are expected to do well as their high capital adequacy and robust branch expansion will enable them to garner a bigger share of the credit and CASA markets. Rajeev Thakkar, CEO, Parag Parikh Financial Advisory Services, recommends large private-sector banks, such as Axis Bank, as they are able to grow fast while maintaining profitability and credit quality.
Positive Outlook
Investors may have to brace for further monetary tightening as the rates are expected to be hiked further, up to 100 bps each, in the next policy review in November.
