Bank Nifty has outperformed Nifty 50 significantly. While Nifty 50 increased by 2%, Bank Nifty is up by 11%. A key reason for Bank Nifty's stellar performance is the NPA level coming down. In addition, credit rate growth has been another reason for Bank Nifty doing very well.
But Bank Nifty's journey in 2022 has been quite patchy. It was not a huge gainer every month. On the contrary, out of the eight months, Bank Nifty was in the red for four and green for four. Moreover, if you take out the July and August rally, purely because of FIIs returning, which they would typically invest in Bank Nifty, Bank Nifty had not given any meaningful returns.
There are a couple of risk factors emerging from the banking sector.
- If you look at the credit growth, it's purely driven by retail, including SMEs as a segment. Most loans are unsecured; hence, when the interest rate rises, two things typically occur: people's ability to service EMIs and increase NPA. Secondly, people's tendency to borrow money diminishes when the interest rate rises. These, we believe, will act as headwinds for the banking sector.
- The credit deposit ratio has started inching up. For every bank, deposits act as raw material. And when there is a shortage of raw material, getting finished goods becomes an issue. So, to ensure more money comes in or to increase deposits, banks start to target CASA deposits. But the competition is extremely stiff. So to increase deposits, banks tend to adopt reaching out to a broader set of people or offer a higher interest rate on deposits. Now, if banks offer higher interest rates, the cost of borrowing rises. When that occurs, they are faced with two choices - either they pass on the cost of borrowing to the borrower, and if that takes place, they could compromise on the quality of the borrower. That's because only the not-so-sound borrowers may be willing to pay a higher interest rate. So if banks don't do that and try to protect it, they could be faced with a hit in margins, which would not be in the bank's interest.
At the same time, banks face challenges from fintechs and large NBFCs who are increasingly eating into their space. However, the need of the hour for every private sector or public sector bank is to invest in digital transformation, which may not be easy. That's because traditional banks need to unlearn to learn anew. Fintechs, on the other hand, do not carry baggage.
The scenario going forward
Given how the world is moving towards digital, there is a high probability that many of these banks would be complete laggards in digital transformation. They may not be able to keep pace; those that do would have to spend a significant amount on digital infrastructure. But the catch here is that the money paid upfront on sprucing infrastructure would not translate into immediate benefits. Hence, we believe there could be margin pressure.
As we advance, banks will have to address some concerns:
- A higher rate of interest could impact the quality of assets.
- The loan growth book.
- Aggressive collection of deposits that could come at the cost of interest margin.
- The challenge of fintech and NBFCs eating into the banking space.
Hence, given these factors, we believe that Bank Nifty can underperform going forward. However, we don't think every bank will disappoint. Similarly, some banks may do exceptionally well, but overall, banking as a sector may not create huge alpha going forward.
We advise investors to be selective regarding bank-stock selections. Please note that banks like HDFC Bank, Axis Bank or IndusInd bank have underperformed the Nifty 50 even for longer periods, as high as five years.
Sunil Damania is the Chief Investment Officer at MarketsMojo.
Disclaimer: Sunil Damania is the Chief Investment Officer at MarketsMojo. The views, thoughts and opinions expressed in this publication are contributions in his personal capacity and do not necessarily represent the views of MarketsMojo or the management.