India’s most tracked stock index Sensex had hit its peak on 10 January just before the bear phase began. Since then, the benchmark index of Asia’s oldest bourse, the 133-year-old Bombay Stock Exchange, or BSE, lost close to 35%. During the market meltdown, eight of the exchange’s 13 sectoral indices have lost more than the Sensex, but the hardest-hit are realty index and Bankex, two sectors that thrive on low interest rates and easy liquidity.
The Reserve Bank of India has raised its policy rate by 75 basis points to 8.5%, and the amount of cash that commercial banks are required to keep with the Indian central bank in the form of cash reserve ratio by 125 basis points to 8.75% in phases this year to fight rising inflation, which is at its 13-year high. One basis point is one hundredth of a percentage point.
When interest rates rise and liquidity gets squeezed, the realty sector suffers the most as the rising cost of money dampens the demand for houses. Banks, too, bear the brunt for a variety of reasons. As the rising interest rate slows the economic growth of the country, banks’ credit growth takes a beating, bringing down their interest income. They also need to provide for the value erosion in their bond portfolio which depreciates as the bond yield goes up and their prices go down.
Under the law, Indian banks are required to invest at least 25% of their deposits in government bonds, but most of them actually buy more bonds than what they are required to. Besides, if they are unable to raise their lending rates, the net interest margin or the spread between their cost of funds and their interest income gets thinner.
Finally, an economic slowdown affects the balance sheets of their corporate clients and this, in turn, impacts the quality of their loan assets. When their non-performing assets, or NPAs, rise, they need to make higher provisions and that eats into their profitability.
All these factors have pulled down BSE’ Bankex, an index that represents 17 listed banks, by 51.67% between 10 January and last Friday. There are 39 listed banks and all of them have lost more than Sensex during this period.
Kotak Mahindra Bank Ltd has lost the maximum—close to 64%. Its stock price has come down from Rs1,247.55 to Rs450.15. There are four more banks that have seen more than 60% value erosion in past six months. They are Development Credit Bank Ltd, Vijaya Bank and two of the State Bank of India’s associates—State Bank of Bikaner and Jaipur and State Bank of Travancore.
These apart, 20 listed banks have seen more than 50% value erosion. This list includes State Bank and the country’s largest private sector lender ICICI Bank Ltd, besides large public sector banks such as Canara Bank and Bank of Baroda. At the bottom of the losers’ list is an old private bank, Dhanalakshmi Bank Ltd, which has seen 28.77% value erosion.
A fallout of the market meltdown is the drastic erosion in banks’ price-to-book value. In fact, half of the listed Indian banks are now trading at a less than one time of their price-to-book as on 31 March. The price-to-book value is calculated by dividing the current closing price of a stock by the latest quarter’s book value per share, or the net worth of a company per share (the sum of a company’s share capital and its free reserves divided by the number of shares). Ideally, book value of a bank’s share should be calculated after adjusting for NPAs.
Kotak Mahindra Bank, which was trading more than 12 times of its price-to-book value in early January is now trading at 4.39 times. Similarly, HDFC Bank Ltd’s price-to-book value has come down from 5.30 times to 3.08. Yes Bank Ltd is now trading at 2.46 times its price to book value, down from 5.80, and Axis Bank Ltd’s price-to-book value has come down from 4.43 times to 2.45. ICICI Bank, which was a trading at a price-to-book value of 3.25 times in January, is now available at a 1.44 times price-to-book.
The public sector banks, which traditionally have lower price-to-book value, have suffered more, and only five of them are now trading at more than one time their price-to-book. They are State Bank and its associate State Bank of Mysore, Bank of India, Punjab National Bank and Union Bank of India. The price-to-book value of Oriental Bank of Commerce is 0.55 times and that of Allahabad Bank 0.58 times. In the first week of January, not a single listed Indian bank was trading at less than one time their price-to-book value.
The price-to-book ratio gives an investor an idea of whether she is paying too much for what will be left if a company goes for liquidation. On the face of it, a lower price-to-book ratio indicates that the stock is undervalued. It could also mean that something is fundamentally wrong with the company.
Indeed, the current macroeconomic scenario is to be blamed for the sudden sharp drop in Indian banks’ price-to-book ratio but public sector banks have particularly suffered because their majority owner, the government, does not give them operational freedom.
The finance ministry forced these banks to cut their loan rates early this year, and now they have merely restored the old lending rates. Freedom to decide on their lending rates would have enhanced their income and stemmed the value erosion on bourses.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to firstname.lastname@example.org