Banks have been the prime beneficiaries of the rally in the stock market after the election results. The Bombay Stock Exchange’s Bankex index has outperformed the Sensex since the announcement of the election results on 16 May. Why are investors putting their money in bank stocks? Why do they think that the prospects of banks have improved after the election results?
A recent note by JPMorgan Chase and Co. analysts Sunil Garg and Sachin Sheth gives a number of reasons for the optimism. The note says that the elections have provided a boost to investor confidence, which “potentially promises revenue opportunities for banks across the spectrum— from infrastructure spend to consumer credit and from investment banking fees to card fees.” In other words, since banks are a play on the economy, the potential for renewed economic growth will also mean gains for banks. Other factors include “potential increase in foreign ownership in the insurance sector, lower government ownership and divestment in public sector companies/banks, a structural reduction in SLR (statutory liquidity ratio) linked to lower deficits and banking sector consolidation.”
The analysts note, however, that several near-term concerns such as margin compression, slower loan growth and worsening asset quality remain. These concerns are clearly seen from the March quarter bank results. Net interest margins (NIMs) have dipped a bit and net interest income growth has been moderate as loan growth slowed. In fact, much of the profits of banks during the March quarter came from high treasury income. Bad loans have increased and according to a note by Emkay Research, if even a quarter of the restructured assets deteriorate into non-performing assets, that would involve a substantial rise in bad loans. As Emkay Research analysts Kashyap Jhaveri and Pradeep Agrawal pointed out in a note dated 14 May 2009, “With key drivers of earnings and RoE (return on equity) being absent, viz., NIMs, treasury gains and asset quality, we remain underweight on the sector.”
True, it’s very probable that the limit on foreign investment in the insurance sector will be increased, which is why the stocks of companies and banks that have insurance subsidiaries have gone up. But “a structural reduction in SLR linked to lower deficits” could be a problem. That’s because increased government spending will be linked to higher, not lower deficits, which, in turn, could mean higher bond yields, which implies lower gains on their bond portfolio for banks. The pressure on margins is likely to continue. Lower government stakes in banks is by no means a done deal.
But banks have been outperforming the Sensex much before the election results were announced. The market is clearly hoping that the reduction in lending rates will boost the economy, which will lead to a recovery and to loan growth. But there are few signs of that so far, with year-on-year growth in non-food credit declining. Here are the numbers of y-o-y growth in non-food credit: 16 January 2009: 22.1%; 13 February 2009: 19.7%; 10 April 2009: 18.8% and 8 May 2009: 17.4%. Unless the new government boosts spending, it will not help loan growth. But if it does boost spending, what will it do to interest rates? That’s what the bond market is worried about, with yields jumping to six-month highs on Wednesday.
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