Why is Banking Stocks Sustainable?

The recent special bulletin brought out by the NSE on the occasion of the index touching 10,000 had an interesting comparison over the last 12 years time frame. Back in 2005, the weightage of banking and financial services in the overall Nifty was just about 12%, with automobiles, oil and IT having around the same weightage in the index. By 2017, this situation had changed drastically. While the other 3 sectors have lost weightage share in the Nifty, the banking and financial services now account for 35% of the weight in the Nifty. That can be partly attributed to more banks joining the index but is also largely explained by the growth in the value of banking stocks.

A more specific case of how banking has outperformed…

A better and more scientific way of looking at the performance of banking stocks will be to see how the banks would have performed if a retail investor had done a SIP on a banking fund by investing just Rs.5000 each month. The chart below captures the gist of this scenario.

The chart above shows the performance of your SIP of Rs.5000/- per month in the Pru ICICI Banking & Financial Services Fund. Since early 2016, there has been a sharp divergence between the amount invested in the SIP and the market value of the SIP. In fact, in the last one year alone the Pru ICICI Banking Fund has returned over 60%, a truly laudable achievement at a time when the Nifty has been a lot more volatile. The question, therefore, is why have banking stocks been in the thick of action and are the factors driving banks really sustainable?

What exactly is driving the banking stocks and is it sustainable?

There are 7 broad reasons why banking stocks are attracting investor interest. Something is surely changing in the Indian banking space…

• Private Banks are fast emerging as a proxy for the Indian growth story. As analysts put it, Indian banks have the advantage of a vast captive market which is still largely unbanked. Over the last few years, initiatives like the Aadhar Linking and Jan Dhan accounts have substantially changed the goal posts making it favourable for Indian banks. They suddenly have a large Indian population that is not only digitally identifiable but also digitally connected. The impact of this on the future of banking could be huge.

• Low cost housing could be a game changer for the Indian banking industry. In the last budget, the government accorded infrastructure status to low cost housing. Conservative estimates are putting the size of the low-cost housing opportunity at around $1.3 trillion. When the projects take off in right earnest, it is also going to open a billion dollar opportunity for the banks in terms of funding and allied services.

• Demonetization has largely changed the name of the game for banking. Nearly Rs.7 trillion was deposited by individuals into their bank accounts. This led to a sharp increase in bank deposits for banks without any additional effort for the banks.

• Technology is likely to drive the future of banking business. Today you can open a bank account simply by identifying yourself with your Aadhar card and you can have a bank account opened almost seamlessly online. Therefore geographical presence is no longer going to be a roadblock for banks to expand. In fact, the 811 account launched by Kotak Bank is one such product where the response has been encouraging.

• With greater deregulation, banks now have the leeway to adjust their asset and liability side of the balance sheet. We have seen SBI take the lead by cutting savings deposit rates by 50 basis points. This is going to boost the net profits of banks by nearly 20%. With inflation staying low, many more banks could follow suit and this could make a substantial difference to the profitability of banks.

• The recent move by the government to bail out banks through the Insolvency code will overcome one of the biggest impediments ahead of Indian banking. While the process will still be long-drawn, at least there is hope that the problem of NPAs and stressed assets can be resolved. That itself could make a substantial difference to the valuation of stressed private banks and most of the PSU banks.

Last, but not the least, there is a silent shift happening in the way individuals allocate money to asset classes. With the combined impact of demonetization and lower yields, investors increasingly prefer the higher alpha of equities. Banks could be the big beneficiaries as this will be a boost for their fee income. Even Dr. Viral Acharya, the RBI governor has pointed to this trend. This shift in the savings pattern could be the biggest factor working in favour of banks and financial services. The rally in banks is, perhaps, just an acknowledgement that there is a paradigm shift happening in the way investors need to look at banking stocks.