As prudent investors, one of our main factor to decide whether we should proceed to invest our funds in a particular fund depends largely upon the performance indicators of that particular fund, generally provided by credible sources; credit rating companies. But, what happens if the ratings provided by such credible sources differ? For example credit rating agency ABC rates a fund or a sector as negative and credit rating agency XYZ rates it on a positive scale? In such scenarios, you as an investor are bound to be confused. In case of the Banking sector, BICRA (Banking Industry Country Risk Assessment) is a tool which is used to rate various banking systems. The scale ranges from 1-10, 1 depicting the lowest risk bearing banking system. This can ease your woes; however, it should not be the only factor you need to assess if you wish to invest in the banking sector.
Things you need to be aware of:
NPA (Non- Performing Assets):
With the recent hike in the RBI’s key policy rates by 525 basis points since March 2010, the rate at which RBI lends to the bank (repo) and the rate at which RBI accepts deposits from the bank (reverse repo)—loans have become costlier by 300-400 bps. The reason why this can be bad news is because such rise in the rates will be passed on to customers who will have to pay higher interest amount on their respective loans. Depending upon the credibility of the customer, sometimes banks can consider the option of extending the loan tenor so that the EMIs remain the same but instead of paying off a loan in 5-10 years in case of a home loan, the tenor might be extended up to 12-15 years. Most times, people may not be able to pay off their debts rendering them as bad debts. These are termed as Non-Performing Assets. At the end of the second quarter, the total NPAs of 37 listed banks put together stands at Rs. 1.06 trillion compared with Rs. 79,078 crore in the corresponding period last year, a rise of close to 32%. So if the rates remain this high, coupled with slow economic growth, these bad debts on loans are bound to rise. This becomes one of the main factors as to why people may not have much confidence in investing in the banking sector.
NIM (Net Interest Margin):
Although banks are bearing the troubled balance sheets, most banks have managed to keep their NIMs high. NIM is basically the difference between the interest banks receive on their advances and the interest they pay to depositors. Higher the NIM, the better. However, with the deregulation of savings bank deposit rates, the ability of banks maintaining high NIMs is quite doubtful. Although, SB deposits account for nearly 25% of the overall deposits a bank holds, the cost of procuring funds at some time or the other will be passed onto the customers who might get lesser interest rates on their deposits. But, increasing it will only increase the NPAs, such that their NIMs will be under pressure, since any drop in NIMs is likely to affect the profitability of the bank eventually making the stocks vulnerable.
Global economic environment:
In its first quarter review in July, RBI in its annual policy statement projected an 8% GDP growth for the current fiscal. Although this can seem quite relieving, things are much serious beneath it. Considering the global economic slowdown, India too is affected since with the slowdown in advanced economies, the emerging economies are likely to be affected. In India, the slow growth can be coined from the fact that the credit growth in the country is experiencing a fall, hence, not proving to benefit the banking sector in any way.
Factors that you can look into
Tax payments:
Generally, a bank’s profitability can be found out by the speed and amount by which they pay out their taxes. If the analyses so obtained show a substantial rise in tax payments, it means that the company has managed to good returns which will help in boosting their stocks. Hence, this news will also play a major factor in the upward movement of the stocks.
Inflation:
With the inflation rising double digits in India, RBI is considering to put a pause to the hike in its interest rates. However an immediate reduction is not something one should expect. Banks may take a huge sigh of relief, if the interest rates are brought down to stable rates due to which their profit margins can up again.
Regulations:
RBI has ensured the regulation it is required to maintain in the banking sector in order to ensure safe and smooth functioning of the monetary system. But, these regulations at times can hamper the growth of banks. For example, when the RBI increased the provisional requirement in areas like real estate, teaser loans etc, it only means that, banks will have to set aside more amount of funds making them lend lesser than usual. These provisions are generally made in those sectors where the regulator feels that business can get a risky so as to reduce the banks programs to such sectors.
Should you invest in stocks now?
There is no doubt that, the banking system in India is going through a rough face; with the economic slowdown on one hand to the slow credit growth coupled with the increase in the number of bad debts. Returns may be very minimal or even negative, but only in the short run. With RBI careful planning procedures, the banking system is sure not to face any systematic risk or deregulation of any sorts, so investing in the long term can be fruitful.