Up 15% in 2022: What's the reason behind Nifty Bank's exceptional performance? Will it continue?

Banking has been the investor-darling sector this year. Stocks from this sector have been a preferred choice for experts and investors alike, even more so in recent times. The index has given exceptional returns, outperforming not only the benchmark but most other sectors in 2022 so far.

The Nifty Bank index has surged 15 percent in 2022 as against a 1 percent rise in Nifty. Last week, on September 15, the Nifty Bank hit its all-time high of 41,840 on the back of an improving economy and strong credit growth.

From June lows of 31,255, the index has recovered over 30 percent. In the last 1 year as well, it has added around 8 percent. However, after hitting its all-time high, the index witnessed some profit bookings.

"The Bank Nifty index witnessed some profit booking at higher levels after being an outperforming index. The index will resume its uptrend once it closes above the level of 42000 where a significant amount of call writing has been witnessed. The downside support stands at 40,000-39,800 and any dip toward that would be an opportunity to buy," said Kunal Shah - Senior Technical & Derivative Analyst at LKP Securities.

In 2022 YTD, all stocks in the Nifty Bank index have given positive returns. Bank of Baroda has surged the most, up over 73 percent followed by Federal Bank, up 48 percent. IndusInd Bank, AU Small Finance Bank, SBI, and ICICI Bank have also advanced between 20-40 percent in this time. Meanwhile, Axis Bank, Bandhan Bank and PNB are up over 10 percent each.

But what is the reason for this outperformance? 

Let's find out.

Brokerage house Axis Securities believes improving economic activity, pick-up in the CAPEX cycle, and improving momentum on credit growth, with credit growth being at a multi-year high and expected to remain buoyant with the festive season round the corner, have been important levers for the outperformance. Additionally, expectations of muted credit cost and strong asset quality are positive for the sector, it added.

Meanwhile, Pranjal Kamra - CEO, of Finology Ventures noted that the outperformance in the sector can be attributed to strong growth prospects, improving financials and traction from foreign investors.

"Owing to increasing interest rates, the NIM margins are expanding, visible clearly in banks’ quarterly reports. The central bank’s report stated that bank credit growth is at 15.5 percent at present, indicating a revival in credit growth. Not only that, with less than 5.8 percent gross NPA rates, bad loans are at decade-low levels now, which means credit quality is also improving. All these factors, along with a strong recovery in FPI buying activity, have given the banking sector a much-needed boost," explained Kamra.

Vinod Nair, Head of Research at Geojit Financial Services also agrees. He also stated that the major factors influencing the performance of banking stocks are asset quality, credit growth and FII activity.

"The recent rally in the market had largely taken into account the improving asset quality, while the market is yet to fully factor the strong traction expected in credit demand. FIIs turning net buyers is an additional catalyst supporting the trend. Even after factoring in the current rally, the Nifty Bank index is still attractive trading marginally above the long-term averages," said Nair.

Sunil Damania, Chief Investment Officer, MarketsMojo also noted that a prominent reason for banking's exceptional performance has been due to the strong return of FIIs seen in July, August and September MTD. FIIs typically hold a passive strategy and invest in the Nifty 50, which is heavily tilted towards banking stocks, explaining the sector's growth, he pointed out. At the same time, NPA levels of the banking sector have reduced, which helped boost market sentiments towards banking stocks, he added.

Ajit Kabi, Banking Analyst at LKP Securities explained that the economy is witnessing a strong credit environment with improving capacity utilisation and capacity expansion. "A healthy credit growth is one of the triggers of better performance of banks. Moreover, a healthy balance sheet, minuscule stress formation and lower credit cost lead to strong profitability. We believe the banks to witness NIMs improvement as the share of floating rate loans is increasing. The sound balance sheet, strong credit growth, healthy margins and lower credit cost are likely to be fruitful for the banking sector," he noted.

Outlook and Top Picks

According to Kamra, the banking sector is expected to continue outperforming on account of improving economic outlook and credit growth recovery. Another factor that outweighs the segment is strong buying by FIIs, he added. Due to the low cost of funds and scale advantages, large-sized banks will benefit the most from this trend, noted Kamra.

Over the medium to long term, amongst the public banks, Axis prefers SBI. While among the private players ICICI Bank and Federal Bank are its top picks.

Meanwhile, Nair of Geojit prefers large private sector banks as he anticipates that they will gain the most from the economic rebound which is backed by solid fundamentals.

"Our top picks are HDFC Bank and ICICI Bank. Amongst mid-sized private banks, we like IDFC First Bank which is expected to showcase robust growth and overcome the legacy issue. We advise SBI among PSBs because of its superior growth prospects and asset quality compared to its peers and margin expansion due to a higher mix of floating rate loans," he said.

According to Kabi, large banks like HDFC Bank, ICICI Bank, SBI, Kotak Bank and Bank of Baroda (BoB) are the major constituents of Bank Nifty and are well placed with superior fundamentals. The large bank may take a competitive advantage factoring the technological advancement. Among large banks, BoB and ICICI are his top picks.

Contrarian view

Even though most analysts are absolutely bullish on the sector going ahead, Damania of MarketsMojo is not very optimistic.

"With smart gains in many of the banking stocks, from this level, we are not very optimistic. We believe NPA levels will begin to rise, and loan growth will take a beating. The reason we say so

is that historically, as and when interest rates have moved up, we have seen loan growth suffer and NPA levels increase. A deeper analysis of the banking sector further reveals that growth in credit is driven by retail," he highlighted.

Damania further noted that generally, retail loans are more prone to NPAs in a rising interest-rate scenario. At the same time, the credit deposit ratio has also gone up and this means banks will need to keep borrowing aggressively to expand their credit books, which could come at a higher cost, further impacting their future NIM, cautions Damania.

He continues to believe that the rally seen in public sector banks is unsustainable because most of them are highly underinvested in technology.

"The future of banking is technology. And public sector banks are highly under-invested in technology. So eventually, they will lose out to some fintechs and private sector banks. A few private sector banks will also face the same challenges because of their underinvestment in technology," he stated.

He recalls a classic example of a prominent company's decline due to poor technology investment. Geico Insurance (owned by Warren Buffet) lagged in investing in the car insurance business by not investing in telematics. Today, it has lost significant market share and business to competitors, as admitted by the management, informed Damania and he believes a similar scenario is likely to play out in the banking sector. Hence, despite their excellent performance, he predicts that public sector banks may not be able to outperform going forward.

However, within private sector banks, he prefers ICICI bank.