Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Identifying a bank stock: Update! - Views on News from Equitymaster
  • E-MAIL
  • A  A  A
  • Jan 7, 2005

    Identifying a bank stock: Update!

    Last year, we did a series of articles on how to identify stocks from various sectors taking the fundamental aspects into consideration. Here is an attempt to re-look at the factors that influence the performance of the banking sector and where these are headed in 2005. To make is simple for investors, we have used arrows in the chart to highlight our key assumptions as far as the banking sector is concerned. Click to read our 'how to identify a banking stock' article.

    A. Interest earned

    Advances: Corporate demand to drive growth

    In the last five years, the key growth driver on the retail side has been housing loans (growing at over 25% per annum). From a very negligible contribution before five years, total retail advances as a percentage of bank advances for the industry is estimated at around 20% levels in FY04. This goes to show the magnitude of growth during the period.

    Given the current retail credit penetration level (estimated at 2% in case of housing loans), we continue to be optimistic about the growth rate of credit on the retail side. Despite thinner margins, retail credit will continue to occupy a substantial portion of the banks' credit portfolio, thanks to the volume growth, on the back of extensive reach. New schemes (better availability) and superior marketing of the same (better awareness) will aid the volume growth. However, we believe that the rate of growth is likely to slowdown in 2005 and beyond. While factors that drive retail credit viz. availability of loans, awareness and real income will increase in 2005 (see graph), interest rates will increase (as it has in the last six months), which will be a dampener.

    Given the fact that gross fixed assets of the manufacturing sector grew only by 2% CAGR in the last five years as compared to a sales growth of 17% in the same period, existing capacities are being fully utilised. With industrial growth expected at more than 6% in 2005, the capex of corporates will increase (to fund expansion). But the caveat here is that, bank credit is no longer the 'most preferred' avenue for raising funds. It now faces tough competition from the capital markets (domestic and international), which is likely to witness a rush of equity and debt issues. All said, banks are expected to focus on their corporate customers for their 'non-food credit' segment, to support their net interest margins. We are positive on this side.

    Investments - Lesser allocation in 2005
    Once bitten, twice shy, the banks are unlikely to overexpose themselves to interest rate risks in investments. With non-food credit picking up, they are expected to deploy majority of their funds in advances rather than investments (a reversal of the trend). Conducive government regulations with regard to enabling consolidation may see banks opting for inorganic growth (domestic and overseas). Thus interest income from investments is likely to be pruned in the coming quarters.

    Given this backdrop of higher corporate credit growth and lower investment income, interest income of banks is expected to grow at a faster rate in 2005.

    B. Interest expended

    Margins - To come under pressure
    The margins that the banks will be anticipating, given the optimism about credit offtake, may not after all materialize, thanks to pressures on the 'interest expended' front. Better investment avenues (offering higher payoffs like equities) will succeed in luring investors away from bank deposits, unless the banking entities offer higher yields. Also, the necessity to augment their Tier II capital (to meet CAR requirements) will see banks go in for additional borrowings. This again will amplify their interest expenditure budgets. A proactive measure on RBI's behalf to maintain price stability (slowing down economic growth by hiking interest rates) could reduce funds available with banks for lending, which then will influence the cost of lending.

    To conclude…
    In 2005, we expect net interest income to come under pressure (interest earned - interest expended), as the latter could shoot up at a faster pace than the former. Of course, the impact could vary bank to bank. The optimism with respect to the sector's future performance needs to be toned down to that extent.

    The caveats:

    • In the backdrop of a rising interest rate along with a fall in the treasury gains, there would be competition amongst banks for the expansion of loan book along with deposit mobilization. This drive would invite a huge credit risk for all the banking entities.

    • The banks' ability to advance credit will be limited to the extent permitted by their CAR (capital adequacy ratio is increasing), which again may pose a major hindrance to most banks, given the need to comply with Basel II norms. This will in turn results in banks tapping the primary market to raise capital. While this will enable banks to fund their expansion plans, there will also be equity dilution (i.e. more number of outstanding shares). Whether all banks have the risk management system and ability to grow ahead of the market remains to be seen.

    • Consolidation could gain pace in 2005. Whether the drive will lend the requisite synergies to the combined entity is another matter of concern.

    • Lastly and more importantly, we believe that the net non-performing assets to advances ratio have bottomed out for the banking sector as a whole. The benefit of higher treasury profits that was supporting the banking sectors move to clean up their balance sheet has exhausted. If investors expect all banks to have low NPA ratios in the future, they are in for some surprise. Economy goes through cycles and the same will influence banking sector. Though the pressure of high NPAs is not likely to be witnessed in 2005, this risk exist beyond that.

    Here we would highlight what we had mentioned earlier. The banking sector plays a very vital role in the working of the economy and it is very important that banks fulfill their roles with utmost integrity. Since banks deal with cash, there have been cases of mismanagement and greed in the global markets. And hence, in the final analysis, investors need to check up on the quality of management. This is the last factor but not the least to be brushed aside.



    Equitymaster requests your view! Post a comment on "Identifying a bank stock: Update!". Click here!


    More Views on News

    IDFC Bank: Strong Trading Income Shields Credit Slowdown (Quarterly Results Update - Detailed)

    Aug 10, 2017

    IDFC Bank is taking steps to address contracting NIMs and successfully transition in to a retail bank.

    ICICI Bank: Loan Slippages Trending Downwards (Quarterly Results Update - Detailed)

    Aug 10, 2017

    Asset quality will be the key thing to watch out for going forward.

    Axis Bank: Outside Watchlist Slippages a Big Worry (Quarterly Results Update - Detailed)

    Jul 31, 2017

    Almost 74% of the watchlist as provided by the bank of Rs 226 billion in FY16 has turned into non-performing assets.

    Should You Take SBI Chief's Advice and Load up on SBI Shares? (The 5 Minute Wrapup)

    Jul 6, 2017

    Does the stock score on the value versus price equation?

    AU Small Finance Bank Ltd. (IPO)

    Jun 27, 2017

    Should one subscribe to the IPO of AU Small Finance Bank Ltd?

    More Views on News

    Most Popular

    Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

    Aug 7, 2017

    The data tells us quite a different story from the one the government is trying to project.

    A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

    Aug 10, 2017

    Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

    Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

    Aug 8, 2017

    Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

    Aug 7, 2017

    Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms


    Aug 18, 2017 (Close)