Banking sector: Growth converging with prices? - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks


Login Failure
(Please do not use this option on a public machine)
  Sign Up | Forgot Password?  

Banking sector: Growth converging with prices?

Mar 10, 2006

India embarked on the trajectory of economic reforms in the wake of a serious balance of payment (BoP) crisis in 1991, with banks being the mainstay of financial intermediation. The objective of the banking sector reforms was to promote a diversified, efficient and competitive financial system with the ultimate objective of institutional strengthening. As the banking system became liberalised and financial markets developed concurrently, the conduct of monetary policy was also tailored taking into account the realities of the changing environment. Tracing the sector's growth justifies the convergence of the same to the valuations awarded to the sector. Countering competition
Beginning from 1992, Indian banks were gradually exposed to the rigours of domestic and international competition. Newly opened banks from the private sector and entry and expansion of several foreign banks resulted in greater competition in both deposit and credit markets. Consequent to these developments, there was a consistent decline in the share of public sector banks in total assets of commercial banks. Notwithstanding such transformation, the public sector banks still remain the mainstay, accounting for nearly three-fourths of the sector's assets and income. It is also important to note that public sector banks have responded to the new challenges of competition, as reflected in the increase in the share of these banks in the overall profit of the banking sector. From the position of net loss in the mid-1990s, in recent years, the share of public sector banks in the profit of the commercial banking system has become broadly commensurate with their share in assets, indicating a broad convergence of profitability across various bank groups. This suggests that, with operational flexibility, public sector banks are competing relatively effectively with private sector and foreign banks.

Rising contribution
The contribution of banking and insurance to the aggregated service sector revenues tripled from 4.6% in FY71 - FY75 to 12.3% in FY00 - FY04. Also, the contribution of the same to the country's GDP increased nearly four folds from 1.8% of GDP in FY71 - FY75 to 6.7% of GDP in FY00 - FY04 (source: RBI). These observations are particularly relevant from the standpoint of the role of banks in the intermediation process. Juxtaposed with the financial sector reforms, this suggests that the enhanced freedom of banks since the liberalisation process has provided them with the flexibility in resource mobilisation and deployment, which has manifested itself in the uptrend in these ratios.

Fine-tuning operations
Banks and the concerned regulatory body (Reserve Bank of India (RBI)) have had to fine-tune their regulatory stance in consonance with the changing market and institutional dynamics so as to balance growth with stability. For instance, with the gradual tightening of prudential norms (shift from 180 days to 90 days regime), the ratio of average NPAs to total advances, which was at a high of 15.7% in FY97, declined to 5.2% in FY05. Prudent loan loss provisioning, securitisation of assets and improved recovery management (through the CDR route) aided the cleansing of the sector's assets. Thanks to this, India today has NPA levels close to that seen in the developed markets.

Also, the capital adequacy of the sector recorded a marked improvement reaching 12.8% in FY05 (well above the stipulated level of 9%) and the sector shows adequate preparedness to comply with the Basel II norms in FY07.

Market rewards
It is thus interesting to note that with the evolution of the sector, stock markets have also come to reward them with better valuations. While the gap amongst the two widened between the 1980's to early 1990's, the subsequent improvement in the sector's fundamentals narrowed down the same. The ratio of the sector's market capitalisation to total assets has improved from 21% in FY70 to 72% in FY05 (Source: RBI).

Nonetheless, without undermining the sector's well-deserved value appreciation, we would like to highlight the caveat to investors - that 'sour mangoes' continue to exist in the basket. Investments in the sector therefore need to be guided with a thorough analysis of key parameters. Also, in well-priced markets (like the current ones), growth visibility and commensurate valuations cannot be ignored even in the case of sector behemoths.

Equitymaster requests your view! Post a comment on "Banking sector: Growth converging with prices?". Click here!


More Views on News

7 Stocks that Mutual Funds Can't get Enough of (Views On News)

Dec 1, 2021

Come hell or high water, these are the top Indian stocks which mutual funds never leave.

5 Indian Banks with the Lowest NPAs. Here's How they Did It... (Views On News)

Sep 27, 2021

These banks have managed to maintain their asset quality even in the middle of a pandemic.

PNB Reports an Over Three-Fold Jump in Net Profit as Provisions Fall (Views On News)

Aug 3, 2021

The reduction in provisions for bad loans and asset quality stability may have aided the lender's earnings.

Here's Why IndusInd Bank's Net Profit Doubled in the June Quarter (Views On News)

Jul 28, 2021

All you need to know about the latest quarterly results of IndusInd Bank.

Axis Bank's Stock Falls as Results Disappoint on Asset Quality (Views On News)

Jul 27, 2021

Axis Bank's net profit more than doubles on a spike in other income and lower provisioning.

More Views on News

Most Popular

Infosys vs TCS: Which is Better? (Views On News)

Nov 26, 2021

In the post pandemic era, the top two IT companies in India are fighting to capture the growing demand for IT.

This Multibagger Stock Zooms 20% After Dolly Khanna Buys Stake (Views On News)

Nov 24, 2021

Shares of this edible oil company zoomed over 50% in three days after ace investor bought around 1% stake.

6 Popular Stocks that Turned into Penny Stocks (Views On News)

Nov 27, 2021

A look at popular stocks that crashed big time and never recovered, i.e. which went from 'Multibaggers to Multibeggers'.

India's Top 5 Monopoly Stocks to Watch Out for (Views On News)

Nov 30, 2021

These 5 companies dominate their sectors with a huge piece of the pie.

The Biggest Winners and Losers in India's Transition to Electric Vehicles (Profit Hunter)

Nov 26, 2021

How India's EV transition could be a major headwind for the incumbents.


Become A Smarter Investor
In Just 5 Minutes

Multibagger Stock Guide 2022
Get our special report Multibagger Stocks Guide (2022 Edition) Now!
We will never sell or rent your email id.
Please read our Terms


Dec 7, 2021 (Close)