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.
Banks: Buyer beware! - Views on News from Equitymaster
  • E-MAIL
  • A  A  A
  • Jun 23, 2006

    Banks: Buyer beware!

    The legendry investor Warren Buffet in an interview to 'Fortune' once quipped, "In economics, interest rates act as gravity behaves in the physical world". The rate hike triggered liquidity drought has put on hold the banking sector's claims of sustenance of a robust credit cycle. The shift from the falling interest rate scenario (FY01 to FY04) to a rising one (FY05 onwards) is expected to have telling impacts on the banking sector. While the former gave the players in the sector the comfort of lower cost of funds, windfall treasury gains and ability to write-off/settle NPAs, the latter will not be as benign. Here, we look at some of the early signs of the same.

    Credit - rate shy: While most banks started hiking their lending rates since 2HFY06 (post IMD redemptions), for players across the sector, it became pertinent to do so once the rise in funding costs became unsustainable. The funding pressure was accentuated in the sub-PLR loan portfolio, which needed an immediate rate revision, leading to most banks raising their PLR rates too. The mortgage loan portfolio witnessed rate hikes to the tune of 200 to 300 basis points as the risk weights on real estate loans were pushed up to 150%. With this, the incremental credit offtake showed a clear sign of deceleration and credit offtake declined by 1% YoY in the first two months of FY07. The decline in credit offtake was also evident from the falling credit to deposit (CD) ratios. The nominal CD ratio is currently at 69.9%. While on the face of it, this ratio may appear comfortable, it must be noted that the incremental CD ratio has sharply dipped. The Reserve Bank of India (RBI's) latest weekly statistical bulletin shows the incremental CD ratio at 43%, which is a three-year low. The same was over 125% in FY05!

    The liquidity meltdown…
    (Rs bn) As on 15/6/06 Growth/(Decline)
    FY06 FY07
    Food credit 391 46 (16)
    Non food credit 14,541 360 (123)
    Total credit 14,931 406 (140)
    Demand deposits 3,314 55 (332)
    Term deposits 18,048 731 604
    Total deposits 21,363 787 272
    Credit / deposit 69.9%
    Source :RBI Weekly Statistical Supplement

    Deposits - hard to come by: The liquidity dry up in the banking system coupled with the RBI's T-Bill auctions has left banks hard-pressed for deposits, more so for low-cost deposits. However, despite the revision in interest rates, the banking sector has witnessed a fall in demand deposits in the current fiscal so far. The term deposits have been better off due to the relative attractiveness of the same due to fiscal benefits.

    Margins - lag effect: As can be seen in the adjacent chart, the net interest margins of banks have a clear correlation to movement in interest rates. While in a falling interest rate scenario, banks defer the passing on the rate benefit to customers (leading to sustenance of higher NIMs), in a rising rate scenario the same deferral happens in case pricing the assets higher (leading to early contraction in margins). The NIMs of banks across the sector have witnessed around 20-30 basis point contraction over the last fiscal.

    Treasury - at mercy of Bond Street: The banks' treasury portfolio, which saw windfall gains during the falling interest rates scenario, bore the brunt of losses as the rates headed upwards. This was on both counts, provision for shift of investments to the HTM basket as well as booking of mark to market (MTM) losses in the AFS basket. Given this, with the 10-year G-Sec yield now hovering at 7.9%, it will be the banks that have majority of the investments in the HTM portfolio and sufficient floating provisions to meet the rising interest rate risks, which will stand hedged against treasury losses.

    Delinquencies - learning from the past: In the previous upturn in interest rate cycle, the adverse impact on banks was the phenomenal rise in delinquency rates (going upto 14% in some cases). This time, however, banks seem to have learnt lessons from the past. Although the possibility of higher NPAs surfacing in the retail credit portfolio cannot be ruled out, banks have better appraisal procedures and provisioning measures in place to keep the same under check.

    Investment in banking stocks...
    While the above caveats should not be construed by investors as a guidance that investment in this sector is a no-no, what we intend to do is make you aware about the changes in the sector's dynamics. It is pertinent that the investment decision in a company in any particular sector is undertaken by considering the fundamentals of the sector. As certain players in the sector may enjoy a competitive edge (for e.g.: banks with above average NIMs, lower NPAs and sufficient floating provisions), investors would be better off keeping their portfolio de-risked by limiting themselves to these.



    Equitymaster requests your view! Post a comment on "Banks: Buyer beware!". 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)