Here’s a DIY guide to choosing banking stocks

Here’s a DIY guide to choosing banking stocks
Written by Publishing Team

While the Nifty 50 has regained much of its recent losses and is slowly heading towards its previous highs (in October 2021), the Bank Nifty has corrected 8 percent from its peak in late October 2021. Expected hike in interest rates, upside risk are defaults due to lockdown Sporadic and subdued credit growth in the past are factors affecting bank stocks. But does this correction pave the way for the accumulation of some long-term bets? We help you summarize them in a few flexible picks within the industry using some of the key metrics in their recent quarterly results.


While an increase in interest rates can pose a risk to banks’ margins, the difference in the product mix (loans and deposits) helps maintain a non-linear relationship between movement in interest rates and margins in the market. Thus, despite keeping policy rates in the status quo for the past two years (since March 2020), few banks have seen improvement in margins due to better product mix. Using the Capitaline database, we shortlisted banks that saw improvement in net interest margins, or maintained the best estimate on their net national income in the fourth quarter of September (on an annual basis).

In the next step, we liquidated banks with total non-performing assets (GNPA) less than 5 percent, to get rid of names that will still struggle with balance sheet cleanups, rather than focus on growth.

The latest Financial Stability Report from the Reserve Bank of India also highlighted that banks saw a slight rise in non-performing assets (NPAs) in the personal loan and agriculture sectors, in the September quarter of 2021, while the industry and services sectors witnessed moderation. As the December 2021 quarter numbers continue to reflect the effects of the 2.0 restructuring, there will likely be more pressure in the retail history only in the following quarters. Regular delays could increase with a third wave leading to further lockdowns and economic slowdown.

Hence, to reinforce our view on the bank’s resilience, we then eliminated banks that showed an increase of more than one percentage point in GNPAs (y/y), in their September fourth quarter results.

Finally, to select banks that are well-qualified to play in the potential upside in credit growth, we shortlisted banks with a current risk-adjusted capital adequacy ratio (CRAR) of at least 15 percent—so that we choose names that are flexible but not limited to that are able to smooth out the economic impact to epidemic but also have enough room for further growth. The Reserve Bank of India (RBI) has mandated a minimum CRAR of 15 per cent for small financial banks (taking into account the riskier sectors in which they operate), while the minimum requirement for scheduled commercial banks is much lower at only 9 per cent.

Margins and GNPAs alone may not be the right way to focus your investment selection within banks. However, this screening can be a starting point for further research into the business that we have highlighted below.

Who made the cut?

ICICI Bank has demonstrated continuous improvements in asset quality and profit margins in the past two quarters. In the September quarter of 2021, as the GNPA rate fell by 35 basis points and the NIMs rose by 43 basis points to 4 percent, ICICI made the cuts.

Next came Kotak Mahindra Bank and HDFC Bank – with the highest NIM rates among the large private banks (4.45 and 4.1 per cent, respectively) – who made the cut. This came despite minor deviations in their margins (HDFC Bank declared profit margins stable) in the last September quarter, due to their cautious approach to credit growth. However, these two banks were able to contain their slips to the GNPA to less than 1 percentage point (on an annual basis), in the last September quarter, despite multiple waves of the pandemic. The long-known superior underwriting skills speak to this resilience in asset quality. Besides the banks are also well capitalized with CRAR above 20 per cent.

Axis Bank, which showed a 65 basis point drop in its GNPA numbers, also cut. However, the bank’s balance sheet cleanup took its toll on its margins – which were down 19 basis points year-over-year in the fourth quarter of September. Investors will need to monitor developments in the bank’s margins in the future.

IndusInd also made the cut, due to the contained expansion in its GNPA numbers (up 56 basis points) and only a 9 basis point decrease in NIMs.

However, as explained earlier, a screening device can at best be a starting point for focusing on your investment choice within the banking field. This is because the sector is now facing many macro events that can negatively affect the financial statements of banks, going forward.

For example, the Reserve Bank of India in its report on the financial services sector highlighted the elevated risks in the portfolios of SMEs (Small and Medium Enterprises) and MFIs (microfinance lending), going forward. Hence, banks such as IndusInd Bank (13 percent of its predecessor comprised of microfinance), Sub-Banks of Implementation (13 percent lenders to SMEs), Pandan Bank (with more than 60 percent exposure to microfinance loans) and Yojivan Bank For microfinance (66 percent of small banking and another 10 percent lent to SMEs), it could see asset quality pressures in the coming quarters, given its increased exposure to these risky sectors.

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January 15 2022


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