Annirudha Chowdhury/Mint
Annirudha Chowdhury/Mint

Banking: where angels fear to tread

While many stocks are trading below their book value and appear ripe for the picking, a prudent investor should consider the following things

Banking stocks have got a bad name in recent times and not without reason. There was an investor exodus after skeletons in the form of bad loans came falling out of the cupboard. Yes, the Nifty PSU Banking Index has rallied 23% since its low point at the end of February, but this just indicates two things. One, stocks had been that badly battered; and two, this is because of central bank rules like relaxation in norms for recognising tier 1 capital.

It is not just public sector banks (PSBs); even private sector banks, which so far appeared to be immune to the non-performing assets (NPAs) meltdown, are now succumbing to it. ICICI Bank Ltd and Axis Bank Ltd being prime examples as their March quarter earnings show.

While many stocks are trading below their book value and appear ripe for the picking, a prudent investor should consider the following things.

First, the clean-up exercise by Reserve Bank of India has led to a surge in bad loans in the past quarter and this is expected to continue into FY17. “We anticipate that the non-performing loan ratios of Indian banks with high exposure to troubled sectors will continue to rise, and credit costs of banks with a backlog of provisions will increase," said Amit Pandey, credit analyst at Standard & Poor’s.

The slippages from large corporate advances are estimated to be in the region of 2.1 trillion for the system between January 2016 and March 2017, with gross NPAs rising to 7.7% in FY17 from 6.8% in FY16 (see chart: NPAs and Slippages to remain high), according to Crisil Ratings estimates. There could also be some stress from banks’ small- and medium-sized enterprise portfolios.

Second, despite the relaxation of capital norms, the banking system will still need further 1.6 trillion in the near term to provide for the stress in the system, according to analysts.

Third, PSBs may not be able to easily pass on the recent rate cut. “Monetary transmission after the 25 basis points cut in April will depend on the PSBs’ ability to cut deposit rates, which remains challenging in the near term," said Siddharth Purohit, analyst, Angel Broking. One basis point is one-hundredth of a percentage point.

While banks have announced marginal cost of funds-based lending rate, the new benchmark lending rates are still close to their base rate and at least 40 bps below commercial paper rates. Demand for short-term loans from companies may not shift to banks from the money market soon. So, credit growth will remain sluggish. Analysts expect credit growth to remain in 11-13% range, recovering marginally from decade lows. This is because capacity utilisation remains low and private investments are yet to take off.

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