Gains in financials hinge on RBI policy, investors must consider options

Nifty Bank outperforming the Nifty50 in recent times could be a sign of things to come

The banking sector and non-banking financials are both in an interesting space. On the one hand, the Reserve Bank of India (RBI) tightening the monetary policy and hiking interest rates are negative developments. But, if the economic recovery continues to have strong momentum, then credit expansion should take place anyway and non-performing assets (NPA) aggregation and credit slippages could be balanced by stronger corporate performance.

It is worth noting that the real interest rates are still negative, despite the policy rate hikes in May and June. Inflation is still running higher than the policy rates and also higher than the yields on risk-free government debt.

There is also a low base effect that could boost earnings and revenues in quarter 1 of financial year 2022-23 (Q1FY23) because Q1FY22 was affected by the second wave of Covid-19. The banking sector could continue to see growth of over 15 per cent year-on-year (YoY). Credit growth for the banking sector was running at 13 per cent YoY for the first 10 weeks of the quarter.

The sequential growth is around 2 -3 per cent, which is mildly positive. Net interest margin (NIM) will start being impacted by the rate hikes from Q2FY23 given the usual lags. However, bottom lines would be negatively affected by the mark to market marking down of bond portfolios since treasury yields were up.

Provisional numbers and channel checks suggest that retail, micro, small and medium enterprises (MSME) and agricultural loans continue to witness strong traction, and corporate loans have also started to show growth revival. Larger banks may be doing better. The inflationary impact has also led to higher working capital needs. Deposit-side growth is expected to remain healthy.

Investors need to balance the positives and the negatives. Improving credit growth and strong NIMs and flat or improving credit costs are positives but the monetary policy trend and other macro factors are negatives.

Retail sector has been driven by 14 per cent growth in mortgages, which implies better real estate performance. Credit card usage has also accelerated. Pricing for most loan products has risen since May. However, home loan rates are still below pre-Covid-19 levels. So far, hikes have not yet impacted demand. Personal vehicle financing has not picked up and this could be a growth segment in the second half of the fiscal, as supply chain issues ease and raw material costs come down.

The banking sector has underperformed the overall market in the last 12 months but it seems to have done comparatively better in the last month. The Nifty 50 has gained 1 per cent in the last 12 months, despite losing 3.5 per cent in the last month. The Bank Nifty is down 2.5 per cent in the last 12 months but only lost 2.8 per cent in the last month. The Bank Nifty is heavily overweight in terms of private bank representation. The Bank PSU index has lost 1.2 per cent in the last 12 months, and lost 2.3 per cent in the last month.

Valuations are moderate across the sector in historical terms, given strong profit growth in the last two quarters. Larger private banks should do better in Q1, but investors will be cautious, given the tightening monetary regime. The next monetary policy in early August could move the sector down if there’s a further hike or liquid-tightening measures. But there could be a relief rally if the central bank maintains the status quo.