Banking on India’s Banking Sector
The banking sector is to the economy what a rudder is to a ship. It steers the economy through rough and clear waters alike, and forges a path during times of economic downturn or shock. In this sense, the Indian banking sector is doing its job, as it continues to expand, providing a necessary force behind India’s growth.
Yet rapid expansion has not yet equated to all round positive growth, profitability and asset quality, as the pace of India’s economic growth has still been slow, with high interest rates and a recent reduction in corporate investment activity. In other words, for the short term investor the banking sector may not present an all too lucrative opportunity.
There is light at the end of the tunnel however. The Indian banking sector has a largely unexplored market, so there is still high potential for growth. RBI Governor Raghuram Rajam recently said, “The banking sector in the country is full of opportunities and in the next two years we will see a number of changes. The public sector banks will undergo tremendous change.”
A little more on the bigger picture follows:
The economic conditions of a country have significant impact on a country’s banking industry. A slowdown in the economy increases the risk of defaults and reduces the asset quality of banks. With the Indian Government making a commitment towards the fiscal health of the economy and declining international oil prices, the Current Account Deficit (CAD) has reached a manageable level. So, while the Indian economy is growing, it is doing so at a slow and steady pace, which helps restore stability.
Increase in Non-Performing Assets (NPA)
The slow growth rate of the Indian economy has resulted in the deterioration of the asset quality of both Public and Private Sector Banks. It has affected the ability of corporate houses to repay loans, which, coupled with inadequate credit appraisal processes in banks (especially PSB’s) has lead to an increase in Non-Performance Assets.
According to the RBI, as of March 2015, the net NPAs of the banking sector increased to 2.36%. As a countermeasure, the RBI reduced its repo rate by 0.25 and has issued instructions and guidelines to banks to improve their asset quality.
Increase in competition
The Indian banking sector is witnessing an increase in the level of competition. Raghuram Rajan has hinted that in the next two years RBI will issue licenses to set up small finance banks and payments banks across the country. “We are going to have a whole set of institutions, payment banks, small finance banks and possibly a postal bank,” he said in a statement. This will reduce market share of existing players, and may impact adversely on their profitability.
Basel III requirements
With increasing NPAs, maintaining a level of capital adequacy as per the Basel III requirements is not easy. RBI estimates that Indian Banks need about Rs.5 trillion to meet Basel III requirements. The economy is improving but with capital constrains, raising such a substantial amount of capital is a challenge for both the banks and the government.
With 151 companies listed in the Indian Banking sector on Trakinvest, the sector has an overall score of only 5.7. A number of challenges and changes look to ensure that growth will remain slow, which does not bid the short-term investor well. With a number of changes in the pipeline for the sector, the long-term investor may consider making a play, but it could still swing in either direction. Check out the Research Hub on Trakinvest to access more sector reports.