An Analysis Of Banking Stocks in the Share Market

Indian banks have been at the center of attention for a variety of reasons in the past couple of years, especially because of the bad loans issue. While banking stocks may have given an on-par performance since the beginning of the year, the correction from the peaks of August has been as sharp as the volatility.  

With an index weight of more than 35% in the Nifty, banking stocks have had a really strong impact on the stock market as a whole. Moreover, they also tend to create a ripple effect on other sectors.

So, how do you evaluate the performance of banking stocks if you are into share trading or want invest in this sector?

Evaluating the performance of the banking stocks(Data Source: NSE)

The above chart captures the relative performance of the NSE Nifty 50 index and the Nifty Private Bank index on a base scale of 100. On a point-to-point basis, the indices look like marginal performers over the last one year, but to get a clearer picture, you need to look at the shaded portion, which captures the Bank Nifty and the Private Bank Index from their respective peaks in late August. That is where the depth of the correction is actually visible.

This sharp correction in banking stocks was driven by a combination of factors, both domestic and global. Remember, we have not really looked at the PSU banking space here, because it is the private banks that have an oversized impact on the Bank Nifty. Today, the market cap of the entire PSU banking space is less than that of HDFC Bank, and hence, the former's ability to influence the Nifty is fairly limited, at least at this point in time.

Looking granularly at the performance of banking stocks since the peak of August

What is driving the performance of banking stocks at this point in time? Let us look at different sets of the financial sector to get a clearer perspective.

• The hit on private banks post August was quite evident. One of the major concerns pertaining to private banks was the valuations part. In fact, there are instances of a newly listed bank like Bandhan Bank trading at a higher P/BV compared to giants like ~25-year-old HDFC Bank. However, the bounce from the lows of October has also been quite sharp, but it is only banks with a good book quality that are really moving up.

• There was a major worry on the movement of bond yields. Bond yields had gone up from around 6.4% last year to 8.2% in the month of September before settling lower at around 7.7% in November as liquidity concerns got addressed. This sharp rise in bond yields entailed depreciation in the bond portfolios of banks and mutual funds. This was supposed to hit banks in two ways: in terms of their own bond portfolios to the extent they had to mark-to-market; and secondly, to the extent of their exposures to debt funds and income funds of mutual funds.

• The IL&FS fiasco was something that spooked banks across the board. Moreover, top public sector banks like SBI and BoB that had a direct exposure to the share capital of IL&FS were the most affected. The stock has since been downgraded to the “Default” status. IL&FS had issued bonds to the tune of nearly Rs91,000cr, of which, 1/4^th are coming up for redemption in the next one year.

• The stress in NBFCs also put pressure on PSU banks. NBFCs were the last-mile delivery partners for PSU banks and the IL&FS fiasco translated into NBFC stress. This has been partially resolved after SBI agreed to a three-fold increase in their funding support to NBFCs from Rs15,000cr to Rs45,000cr.

Now, for the performance of the PSU banking stocks
(Data Source: NSE)

From the above chart, it is clear that while the losses in private bank stocks managed to recover, stocks of PSU banks are still down over 20% on a yoy basis. In the case of private banks, the fall was more due to a valuation froth, which has tapered since then. However, in the case of PSU banks, it was more due to the NBFC crisis and concerns over rising NPA provisions.

So how to approach banking stocks in this market?

This is a critical question, especially at this juncture. Your approach to banks must be predicated on three factors.

Firstly, a good part of the valuation froth in private banks may be out and quality private banks are offering more reliable levels of entry.

Secondly, PSU banks may have gotten over the immediate worry of the bond market crunch but the bond depreciation from higher yields still remains. That is a hit that banks will have to take during this year.

Finally, we come to NBFCs. Here, the RBI has already hinted at a more stringent regulatory framework and that could drastically change the face of NBFC investing.

So approach this segment with care.