The banking maze: let the experts guide you

BFSI companies form the backbone of the Indian listed equity space and are key participants in most Indian bull markets. Over the last one and a half years, the banking sector has seen a fair amount of volatility and regulatory changes, and in April 2024, the Nifty Bank index hit a new lifetime high.

Given that banks are looking at a potential comeback after their post-Covid lull, would-be investors are understandably keen to get more clarity regarding this sector.

In a recent episode of the ‘Adding Zeroes’ podcast, Kumar Saurabh (Director, Technofunda Ventures Pvt. Ltd.) and Dhaval Gada (VP, Investments at DSPAM) discussed the banking sector with host Sahil Kapoor (Head of Products and Market Strategist at DSPAM).

Here are their answers to some of the most pressing questions you might have as an investor:

1. How should investors approach the banking sector?

There are two classic ways to approach any market:

1. The value-based approach, where investors look at long-term performance and various fundamental metrics, and where they seek some kind of margin of safety

2. The momentum-based approach, where investors focus on recent performance regardless of fundamentals

Investors looking to invest in banks based on their fundamentals should pay attention to valuations, growth, and various banking-specific cycles such as the credit cycle and NPA (non-performing assets) cycle. Metrics such as the P/B (price-to-book) ratio, when compared with the average long-term P/B ratio, can help investors identify price discounts or premiums.

For investors following the second style, it’s important to keep an eye on the price and volume action, and to compare the relative strength of banking indices with the Nifty 50 index to identify uptrends and breakouts that might indicate good entry points.

2. What key insights about the banking sector can we gather by looking at the longer-term picture?

On the asset side, in terms of growth rate, NPAs, etc., most things look good, with few challenges.

FII (foreign institutional investor) selling could become a challenge in the near future. Banking is a very high-float industry, and promoter holdings are relatively low, so if the supply keeps growing due to such selling, it’s not clear how the market might react to it.

On the liability side, the declining CASA (Current Account and Savings Account) ratio and deposit growth rate might simply be short-term challenges, or they might be symptomatic of something structural.

One trend that’s visible is that the PAT (profit after tax) growth rate is slowing down, and looks relatively low compared to the NIM (net interest margin) growth rate. There are various theories as to why this is happening, but it’s definitely something that investors should keep an eye on.

3. Does the current market momentum favour PSU banks over private banks?

The domestic economy is doing well. Five years ago, sectors that were asset-light were looked upon favourably, but now, we’re seeing asset-heavy sectors like manufacturing, infrastructure, and real estate doing well. The lending for such sectors mostly comes from PSU banks.

So what we can say for now is that PSU banks are performing well, the sectors they lend to are performing well, and there’s a growth opportunity here.

As far as private banks are concerned, there seems to be a clear case of value emerging among them. If we look at some historical book value comparisons, we’re probably somewhere in the ‘fair’ zone in terms of valuations.

So for somebody with a value-oriented mindset, private banks ought to provide an opportunity, while somebody who wants to look at momentum might want to consider PSU as well as private banks.

4. Is now a good time to generate Alpha amidst market volatility, especially through active management?

In relative terms, banking looks to be a decent bet to generate excess returns right now. Active investing can help on that front, and investors have lots of instruments available to them right now that they can use to craft various approaches based on their risk appetites.

5. Can NBFCs benefit more or perform better in a rate-cut cycle like the current one versus banks?

Between 2022 and 2024, when we saw bank margins expand, we also saw pressures on the margins of NBFCs and some wholesale-funded private banks. So this latter basket might see some relief in terms of profitability, at least on the margin side, when the cycle turns. So in an environment where rates were to go down, or if at least there are some signals of that happening, NBFCs should perform better.

6. Right now, should investors be overweight in the banking and NBFC sector, or underweight?

Currently, there seems to be some margin of safety. We are either close to fair value or seeing some more value emerge in certain pockets. There doesn’t appear to be any real asset quality stress right now. Moreover, we’re seeing under-ownership of certain stocks that have seen selling from institutions, for instance.

So this could be a good time to be overweight on BFSI companies as a whole if you’re looking for decent returns.This sector might perform well not just relatively, but in absolute terms as well, and the risk-reward balance seems attractive. For investors mainly focusing on small-caps, banks, especially large-cap banks, can be a good supplementary investment.

The behemoth that is banking: more insights

Love it or hate it, the sheer size and heft of the banking sector makes it impossible to ignore. For more deep insights into this sector’s prospects, check out this episode of the ‘Adding Zeroes’ podcast.