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Don't bank too much on these stocks

Oct 15, 2009

The BSE-Bankex touched its 52-week high of 10,192 yesterday. Of the 18 banks that constitute this index, 15 have climbed to their 52-week high this month, out of which 12 touched their highs yesterday. The rationale for the investment attractiveness of this sector has been compelling enough. For every Rs 100 invested in this benchmark index since its March 2009 low of 3,633, you would have received Rs 280 till date. The same amount invested in the BSE-Sensex during its March low of 8,160 would have yielded you Rs 211 till date. Their relative risk-averseness compared to their foreign peers and better regulation has warranted the revised valuations of banking stocks in India. While there are banks that have pared their balance sheet sizes in FY09, others have prudently provided for possible slippages. Also there were many cases of loan restructuring due to the economic slump.

Nonetheless, the Indian banking sector continued to remain very healthy as compared to its global counterparts in terms of systemic risks and safety of depositors' money. Picture this against the rampant bank failures in the US and Europe. The entities in India and their investors have therefore been commensurately rewarded.

But investors must not lose sight of the fact that although the long term potential of the Indian financial sector remains intact, the near term risks could surface unpredictably. The honeymoon period of low interest rates are now numbered and most banks may soon start facing pressure on their net interest margins (NIMs). The incremental credit growth is expected to remain muted in FY10 with the supply of credit continuing to outstrip demand.

Further, with little upside in margins, banks are expected to rely heavily on their fee income generating abilities in addition to their operating leverage. Also, most banks envisage higher loan restructuring and provisioning costs this fiscal, which could eat into their profits.

Keeping these risks in mind, investors must necessarily adopt a bottom up approach when it comes to investing in the banking sector. This is given that valuations at the current levels seem to fairly price in the medium term prospects.

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