Banking stocks have started outperforming BSE’s benchmark Sensex. Since the beginning of the year, the banking index of the bourse, the Bankex, has gained 13.1%, while the Sensex has advanced 6.7%. Is this outperformance sustainable because of hopes of a rate cut?
There are precedents. When the Reserve Bank of India (RBI) cut the repo rates by 100 basis points (bps) in 2002 after the dot-com bust, the BSE Bankex rallied 34.28%, while the Sensex gained 3.52% that year. In 2004, the Bankex gained 32.97%, while the Sensex was up 13.08%. And in 2009, right after the Lehman crisis, the Bankex outperformed the Sensex by a small margin following a steep cut in the repo rate by 275 bps. A basis point is one-hundredth of a percentage point. This year, economists are factoring in a 100-125 bps rate cut by RBI. When interest rates start falling, banks also benefit from higher net interest margins as deposits get re-priced sooner than loans.
But there are plenty of other concerns for bank stocks. “Asset quality is expected to remain under pressure due to slowing growth and gross bad loans could rise by 40% in FY13,” said Vaibhav Agrawal, vice-president (research) at Angel Broking Ltd. Gross bad loans were up 33% in November compared with last year, according to a Mint analysis. There is a six-nine months lagged impact of slowing growth on the asset quality of banks.
Analysts estimate that restructured assets of state-owned banks can go up to 7% of the total loan book in FY13 from the FY12 estimate of 4-5%, and for private banks it can go up to 2% from 0.5-1% in FY12. Agrawal expects flat earnings growth for public sector banks in FY13, while private banks may continue to post a robust growth of 25%.
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But could the earnings impact of slowing growth be offset by the upside in bond prices, as a result of rate cuts? Bond yields have started factoring in monetary easing as the 10-year G-Sec yields slipped to 8.22% recently from a high of 8.97% in mid-November. JPMorgan India Pvt. Ltd in a report dated 13 January said it expects softening of bond yields due to weaker loan demand and easier liquidity scenario, although challenges of increasing fiscal slippage remain.
The problem is one big difference between the early 2000s and now. The predominant part of banks’ bond portfolios are now in the “held to maturity” category, while it is bonds in the “available for sale” group that can reap the benefit of mark-to-market gains from higher bond prices. That is why analysts continue to be cautious on the sector.
Graphic by Paras Jain/Mint
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