Can you bank on this winning streak?

The banking sector is on a dream run, outperforming its peers over the past three years. Tanvi Varma finds out whether the upswing will continue.

Tanvi Varma/Money Today        Print Edition: October 2010

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.

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