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Banking Sector Analysis Report 

[Key Points | Financial Year '20 | Prospects | Sector Do's and dont's]

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  • The Indian banking system consists of public sector banks, private sector banks, foreign banks, regional rural banks, urban cooperative banks and rural cooperative banks, in addition to cooperative credit institutions.
  • India's Credit-to-Gross Domestic Product (GDP) ratio is 56%, lower than most advanced economies or even China where it is in the range of 150-200%. However, demand for credit has surged over the past decade, aided by strong economic growth, rising disposable incomes, increasing consumerism & easier access to credit.
  • Indian banks are increasingly focusing on adopting integrated approach to risk management. Banks have already embraced the international banking supervision accord of Basel II, and majority of the banks already meet capital requirements of Basel III.
  • The increasingly dynamic business scenario and financial sophistication has increased the need for customized exotic financial products. Banks are developing innovative financial products and advanced risk management methods to capture market share.
  • Access to the banking system has improved over the years due to persistent effort from the Government to promote banking technology and promote expansion in unbanked and metropolitan regions. The Ministry of Finance launched the Jan Dhan Yojana in 2014, a financial inclusion program to expand affordable access to financial services such as bank accounts, credit, insurance and pensions in all parts of India.
  • Digital influence in the Indian banking sector has also grown due to rising digital footprint. Real Time Gross Settlement (RTGS) and National Electronic Funds Transfer (NEFT) have been implemented by Indian Banks for fund transactions. The market regulator has included both these payments systems to the existing list of methods that a company can use for payment of dividends or other cash benefits to their shareholders and investors.
  • The Reserve Bank of India (RBI) has taken several steps to enable mobile payments, which forms an important part of mobile banking. The National Payments Corporation of India has developed the Unified Payments Interface (UPI), an instant real-time payment system that works by instantly transferring funds between two bank accounts on a mobile platform.

How to Research the Banking Sector (Key Points)

  • Supply
  • Liquidity is controlled by the Reserve Bank of India (RBI).
  • Demand
  • Rising incomes are expected to enhance the need for banking services in rural areas and therefore drive the growth of the sector.
  • Barriers to entry
  • High, due to licensing requirement, investment in technology and branch network, capital and regulatory requirements. The role of trust also acts as a major barrier to entry for new banks looking to compete with major banks, as consumer are more likely to allow one bank to hold all their accounts and service their financial needs.
  • Bargaining power of suppliers
  • Low, as banks are subject to rules and regulations of the RBI. Customers have also hedged inflation by investing in riskier avenues besides banks.
  • Bargaining power of customers
  • High, for good creditworthy borrowers due to the availability of large number of banks and low switching costs.
  • Competition
  • High. With entry of foreign banks, competition in the Indian banking sector has intensified. Banks are increasingly looking at consolidation to derive greater benefits such as enhanced synergy, cost take-outs from economies of scale, and diversification of risks. The RBI has also approved for small finance banks and payment banks which will further increase competition in the industry
  • Threat of Substitutes
  • Loans, insurances, mutual funds, and fixed income securities are some of the many banking services that are also offered by NBFCs. Technological developments and the threat of payment method substitutes may also lead to substitution of some of the services provided by the banks

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Financial Year '20

  • The banking sector saw subdued credit growth during FY20. Bank credit growth fell from about 14.5% of the GDP at the beginning of the year to 6.2% by March 2020. Credit growth to industry decelerated to 0.7% in March 2020 from 6.9% in March 2019. Credit growth to services saw a much sharper slowdown to 7.4% from 17.8% over the same period.
  • Deposit growth was higher compared to credit growth during FY20, though there was a drop in growth at the end of March 2020. Growth in total deposits to GDP remained above 9% through the year, but dropped to 7.9% in FY20.
  • In June 2019, the RBI announced the introduction of an electronic trading platform for buying/selling foreign exchange by retail customers of banks. The platform can be accessed by any customer of a bank who has a need to purchase or sell US dollar against the rupee for delivery on cash basis, tom basis or spot basis subject to certain conditions
  • FY20 was an extremely challenging year for the Indian economy. Both monetary and fiscal policy support was employed to counter the slowdown during the year. The RBI introduced a new liquidity management framework, under which it started long-term repo operations to provide durable liquidity to banks.
  • The central bank also put in place a new external benchmark regime for loans to speed up transmission of policy rate cuts to bank lending rates. The Repo rate was cut by 1.85% over the year, with 0.75% reduction in March coming specifically to counter the pandemic related activity disruption.
  • Prior to the onset of the Covid-19 pandemic, the RBI issued revised guidelines for resolution of stressed assets, which allowed lenders to decide on referring an account for resolution under the Insolvency and Bankruptcy Code. It also amended the Insolvency and Bankruptcy Code to give priority to financial creditors ahead of operational creditors in case of liquidation.
  • In March 2020, RBI imposed a moratorium restricting deposit withdrawals from Yes Bank, followed by implementation of a scheme of reconstruction involving change in management and equity capital infusion by several Indian banks. The bank also wrote down additional tier-1 bonds.
  • The government also announced the amalgamation of 10 public sector banks into four big banks. This merger was effective from April 1, 2020. As per the scheme, Oriental Bank of Commerce and United Bank of India will be merged into Punjab National Bank; Syndicate Bank into Canara Bank; Allahabad Bank into Indian Bank; and Andhra and Corporation Bank into Union Bank of India. Including the past mergers, the total count of public sector banks has come down from 27 banks (including SBI and its associates) to 12 banks.
  • In May 2020, the central government announced Rs 20 trillion economic package to provide liquidity and credit support to businesses during the pandemic, especially MSMEs, develop farm sector infrastructure and to ensure livelihoods for migrant workers. Alongside major long term structural reforms were also initiated.
  • The central bank also announced a moratorium on all loans until August 2020, in order to help borrowers' tide through their own cash flow problems. Furthermore, the RBI asked banks to not pay dividends from their retained income for FY20 in order to help them strengthen their capital position.
  • Following the national lockdown, asset quality (NPA) concerns increased with several sectors witnessing a sudden stop in activity. According to the RBI's Financial Stability Report, the gross NPAs of the banking sector could rise to a two decade high of 14.7% of total loans by March 2021. As of March 2020, the gross NPA ratio stood at 8.5% of total advances. In order to avoid a liquidity crisis and ensure financial stability, the RBI reduced the mandated cash reserve ratio (CRR) by 1% for the first time in 7 years, provided targeted long-term liquidity facilities for banks to buy corporate bonds and on-lend to non-bank financial institutions.
  • In November 2020, the RBI imposed a moratorium on Lakshmi Vilas Bank (LVB) for a period of 1 month, effective November 17 as the financial position of the bank underwent a steady decline, with continuous losses over the last three years eroding the bank's net-worth. It also announced the amalgamation of Lakshmi Vilas Bank and DBS Bank after putting LVB under moratorium.

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Prospects

  • Rising per capita income will lead to an increase in the share of the Indian population that uses banking services. Population in the 15-64 age group is expected to grow strongly going ahead, giving further push to the number of customers in the banking sector. Growth in disposable income will also encourage households to raise their standard of living and boost demand for personal credit.
  • Rising income in rural areas is expected to enhance the need for banking services in rural areas. Programs like the MNREGA, which was further aided by the recent Jan Dhan Yojana, have helped in increasing rural income. The real annual disposable household income in rural India is forecast to grow at a CAGR of 3.6% over the next 15 years.
  • Soaring tele-density in rural areas also opens avenues for vast unbanked population and highlights scope for innovation in delivery. Mobile, internet banking and extension of facilities at ATM stations will help improve operational efficiency in these areas. The growth of mobile banking could impact the banking sector significantly.
  • Agriculture requires timely credit to enable smooth functioning. 51.4% of nearly 89.3 million farm households do not have access to any credit, either from institutional or non-institutional sources and only one-eighth of farm households avail bank credit. Local money lending practices in rural areas involve interest rates well above 30% therefore making bank credit a compelling alternative.
  • Housing finance is expected to be another key growth driver for the banking sector. Rapid urbanization, decreasing household size and easier availability of home loans has been driving demand for housing. Demand in the low and mid income segment exceeds supply three-to-four fold.
  • Wide policy support in the form of private sector participation and liquidity infusion can further help the banking sector. Significant growth is possible in private sector lending as credit disbursal by private sector banks is expected to increase.
  • Healthy regulatory oversight and credible monetary policy by the RBI can also help lend strength and stability to the sector.

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FAQs on the Banking Sector

How has the banking sector performed in the past decade and when is a good time to invest in the sector?

The banking sector has been one of the sectors that has driven the stock market rally in the past decade giving returns of more than 200%. However, since March 2020, the sector has been one of the worst performing sectors and has recovered only starting November 2020, once there was some clarity on the Covid-19 vaccines.

Banking stocks are very closely linked to economy as both credit growth and margins are dependent on GDP growth and interest rates. Banks tend to have high non-performing assets (NPAs) when interest rates are high and economy is underperforming and vice versa.

Therefore, the best time to buy banking stocks is when interest rates start falling as the cost of borrowing for banks goes down immediately while the interest they charge on loans stays high and falls with a lag.

To know more about the sector's past and ongoing performance, have a look at the performance of the NIFTY Bank Index and BSE Bankex Index.

Where can I find a list of banking stocks?

The details of listed banks can be found on the NSE and BSE website. However, the financial information on these websites can be overwhelming.

For a more direct and concise view of this information, you can check out our list of banking stocks.

Which banking stocks were the top performers over the last 5 years?

IndusInd Bank, HDFC Bank and Kotak Mahindra Bank were the top performers over the last 5 years in terms of sales and profit growth.

IndusInd Bank's growth can be attributed to its innovative product offerings and its unwillingness to compromise on asset quality whereas HDFC Bank's growth can be attributed to its long track record of operations, comfortable capitalization levels and stable top management team.

Kotak Mahindra Bank has also done well on the back of its stringent underwriting standards, strong risk management systems and processes, and rigorous collection measures.

To know which other companies performed well over the last 5 years, check out our entire list of top performers.

What kind of dividend yields do banking stocks offer?

Since banks have to provision for potential bad loans (NPAs), these provisions generally lower profits for the bank. And as dividends are mostly paid from the remaining share of profits once essential expenses are met, not all banking stocks can steer you to handsome dividends.

In the Indian banking sector, private sector banks tend to have relatively better control on asset quality i.e., NPAs but don't pay high dividends whereas PSU Banks being government owned pay healthy dividends but can be risky in terms of NPAs.

To know which banks pay dividends, check out our list of top banking stocks offering high dividend yields.

Which are the banking stocks with the best shareholder returns?

Shareholder returns measure the total returns generated by a stock to an investor. This profitability helps gauge a company's effectiveness when it comes to using equity funding to run its daily operations. In the Indian stock market, HDFC Bank, IndusInd Bank and Bandhan Bank are the top finance stocks right now with the best shareholder returns.

To know which other banking stocks offer great return on equity, you can check out the top banking stocks offering the best shareholder returns here.

Which are the best banking stocks to invest in currently?

Investing in stocks requires careful analysis of financial data to find out a company's true worth. However, an easier way to find out about a company's performance is to look at its financial ratios.

The most commonly ratios for banks are the Net NPA to Advances ratio and Price to Adjusted Book Value ratio, which is the ratio of Price to Book Value adjusted for NPA per share.

  • Price to Book Value Ratio (P/BV) - It compares a firm's market capitalization to its book value. A high P/BV indicates markets believe the company's assets to be undervalued and vice versa.

    To find stocks with favorable P/BV Ratios, check out our list of banking stocks according to their P/BV Ratios

Resources on the Banking sector

Views on News

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.

ICICI Bank's Quarterly Results Sends Stock to 52-Week High (Views On News)

Jul 26, 2021

ICICI Bank expects to maintain margins at the same level in coming quarter.

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