Improvement in quality of Indian Banks:
The quality of Indian banks has improved dramatically. The farm loan waivers and its compensation to the banks by the government has aided this process. Over the last few years, one has seen stupendous amount of improvement in the quality of overall banking and financial space in India, especially now when it is compared with the rest of the world or probably global financial markets. The banks, especially the PSU banks are coming up quite attractively on the valuation front.
Why Banks now?
The time is opportune because banks stocks have been pummelled quite a bit in the recent past – there are no unrealistic expectations from the sector currently and valuations are extremely attractive.
If one has a horizon of two-three years and bearing in mind their recent underperformance, it is very clear that this is a sector which has secular growth potential. There is no issue about that.
The Indian economy is under banked. There is huge potential. Also, the quality of Indian banks has improved dramatically over the last few years and one can see tremendous improvement in the quality of overall banking and financial space in India. It is comparable with the rest of the world or probably global financial markets. Indian banks are doing very well on that score and this is bound to get noticed.
What about interest rates and inflation?
Despite expectations about interest rate hardening or maybe high inflation going forward, it must be realized that the banking sector is one that has consistent profitability. It should be noted that over the last 15 years, net interest margins of banking companies have been almost stable at around 3% irrespective of interest rates cycles. The reason for this consistency is the fact that the banking sector is a “pass through sector”. It represents a good pass through mechanism.
One can be assured that over a period of time, banks will enjoy consistent profitability.
From that point of view, the present valuations look extremely attractive.
What about bad loans pressure?
A lot of the negatives arising from the sub-prime crises and the consequent bad loans is already there in the price. The market has in fact over-discounted the negatives in the current pricing.
If one considers the valuations and asks oneself what is the implied profit growth of banks that is to be expected at the current prices, it is only about 9 to 10 per cent. While, the reality is that banks are enjoying a profit growth of about 20 to 25% in the past five years.
This also shows that the current valuations are very attractive.
There is no need to be concerned about the farm loan waiver issue because the Government has repeatedly clarified that no part of the burden will fall on the banks but will be paid through the consolidated fund of India. The waiver is therefore a positive factor for the banks because while it might have otherwise have to write-off the whole of the delinquent loans, now the whole or a part of the loan will be recoverable by it.
Even in a worse-case scenario, the impact will hardly be 3 to 4% of the book value of the banks.
Some top picks for you:
Public Sector Banks
State Bank of India:
Bank of India.
Private Sector Banks: