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Private banks: Wrongly rewarded, wrongly punished - Views on News from Equitymaster
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  • Apr 7, 2000

    Private banks: Wrongly rewarded, wrongly punished

    India's new generation private sector banks, represented by HDFC Bank and ICICI Bank, have in recent months defied the laws of gravity by registering fantastic increases in market capitalisation. However, the recent crash has brought to the fore the market excesses in valuing these stocks.

    Bank stocks lose their lustre...

    The private sector banks, and this is indisputable, benefit largely from the use of technology. They are able to solicit more business (as they can then offer better services) as well as post better margins (technology helps them to conduct business more efficiently). And most importantly, these banks have cleaner balance sheets as compared to their public sector peers.

    Is the recent crash in market values of these stocks justified? Maybe, given that these stocks were being valued more for their Internet plans (Internet stock trading, e-commerce plans) and anything related to technology got a beating in the past few days. However, the banking business still looks attractive. And maybe it is time to take a re-look at these stocks.

    The fundamental business of banks is to provide credit to various sectors of the economy. With the economy picking up, the credit business of the banks is likely to get a boost. Infact, bank credit grew by 15.3% during FY00 as compared to just 9.6% in the previous year. The enhanced demand for credit will reflect as higher interest income in a banks’ financial statement. Further, the RBI’s decision to lower the cash reserve ratio (CRR) will benefit banks. They will now be able to deploy these funds at market related rates of interest (approximately 12%) as against the 4% that the RBI was paying on these deposits. The recent cut in interest rates could spur higher demand for borrowed funds. Also, as capacity utilisation levels improve in view of the rise in demand, higher level of investment activity will benefit demand for credit, thus boosting business.

    Next come the value added services – foreign exchange, depositories, cash management, product financing among others. These aspects the business have all registered significant rates of growth in the last few months in view of the rise in domestic and international economic activity. As the economy gains momentum and becomes more inter-linked in the global economy, these services will contribute to faster growth – resulting in more business.

    Among the other factors that make the banking business seem attractive is the declining trend in the interest rates. Given the large quantum of debt securities that are held by banks in their investment portfolio, even a small decline in rates is likely to increase the value of their investments significantly. This will also reflect in the bottomline of banks.

    The banking sector in India is definitely poised for a quantum leap in India. With private sector banks having the edge of technology over their public sector peers, the gains will be unevenly shared.

    The banking sector commands a 4.1% weightage in the BSE Sensex.



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