Banking correction – should you be brave or careful?


The banking sector is currently in the eye of a perfect storm. Just when it seemed that the bad loan problem was easing, the latest RBI circular directing banks to recognise all non-performing assets upfront complicated matters. And a bigger blow followed with the revelation of a Rs 11,400 crore fraud at Punjab National Bank. Investors mercilessly punished the sector—particularly state-owned banks–by dumping the shares.

Is it time to go bottom fishing or should one exercise caution?

Bad to get worse

State-owned banks reported an aggregate loss of Rs 18,097 crore for the December quarter, the fourth consecutive quarter of loss. Earnings were hit by rising provision (especially since a large chunk of bad assets have headed towards resolution under the Insolvency & Bankruptcy Code) on non-performing loans and lower treasury gains as yields firmed up.

The private pack reported a profit of Rs 11,154 crore, therefore making it a net loss quarter for the aggregate listed banking universe.

Aren’t there green shoots?

The sector is, however, interestingly poised. With credit growth picking up to double-digits now from the nadir of 5% that it had touched in the earlier part of 2017, momentum appears to be gradually coming back. With drying up of systemic liquidity and firming up of wholesale funding rates, nascent signs of pricing power is also getting visible.

But that’s one side of the story. Concerns of inflation and fiscal slippages are pushing up yields on government securities, thereby eating into the treasury gains of banks. Finally the draconian circular of RBI that virtually closes the door to ever greening of bad assets and warrants upfront recognition and speedier clean-up can only widen losses in the short term.

More near term pain

During the December quarter, there was a net addition of Rs 43,292 crore  to gross non-performing assets of PSU banks. This was mainly due to asset quality divergence highlighted by the RBI for few large banks.

Our analysis suggests that should RBI’s new circular (that disallows erstwhile restructuring like SDR, S4A etc.) gets implemented in letter and spirit, the addition to the NPA (non-performing asset) pool could be around Rs 2.5 lakh crore.

PSU banks, on an aggregate basis have created provisions of Rs 66,500 crore in the December quarter. Given the likely elevated level of slippage, the provisioning requirement will remain high (At least Rs 1.25 – Rs 1.5 lakh crore) in the coming quarters as well. So expect big losses to continue from the PSU pack.


Moreover, post the incidence of fraud involving jewellery accounts, every transaction of bankers will be subject to greater scrutiny thereby not only slowing down business momentum but also the pace of asset quality resolution.

The recapitalisation money for government banks will at the most fund the asset clean up, leaving the onus of raising growth capital from the markets. We see little possibility of PSUs successfully raising capital on their own from the markets barring a few like State Bank of India or the better performing smaller ones like Indian Bank.

What should you do with PSU banks?

Hence, not only will the numbers be bad, but also an environmentl for PSU banks to grow and compete does not exist. Hence, the correction doesn’t make us enthusiastic about PSU banks in general. We are, nevertheless, hopeful of big bang reforms (involving mergers & acquisitions/restructuring/autonomy) in this space post 2019 election but wouldn’t recommend buying any unviable bank on the basis of this expectation now.

With close to 25% share of the banking system, we do see SBI surviving this mayhem. The bank has a mandate to raise Rs 20,000 crore of growth capital from the market in FY19 – an event investors should be closely following. While SBI might see volatility in numbers for the coming three quarters, the stock has corrected by close to 24% from its highs. Hence, any further weakness is an opportunity for long-term accumulation.

The market for the winners – private banks

For most private banks, it has been a dream run that is likely to continue in this manner in the foreseeable future.


All of them are well-capitalised, have a very strong low-cost deposit base that is a distinctive competitive advantage in a system where everyone is chasing high quality credit.


For corporate focused entities like Axis, ICICI or Federal, provision linked near term volatility/weakness in earnings cannot be ruled out.


We see retail-focused lenders like HDFC Bank, Kotak Bank, IndusInd Bank to continue to have a strong run and in fact gain market share in corporate business as well. Any weakness in the market is therefore a great opportunity to accumulate these banks.

For corporate focused lenders (Axis, ICICI, Yes & Federal), couple of quarters of higher provisioning and hence some volatility in earnings cannot be ruled out. Investors should therefore patiently wait for the negative surprises to play out to accumulate the weakness in these banks as they too will have a long smooth run post this hiccup.moneycontrol