It's very difficult to understand the Banking business thoroughly. However, to find some safer banking stocks one should look at the parameters given below.
1) Core business: The core business of a bank is to lend, so it's important to see how the advances have grown in the past, at least in the last few quarters. Looking at the growth in the interest income will also give you a fair idea. But, remember, this is only a necessary but not a sufficient condition. As there is a possibility that to gain market share the bank might be ignoring the quality of lending.
2) Crests And Troughs:
Although banking stocks fell along with the overall market as global crisis intensified, it has rebounded sharply and outpaced the overall market on prospects of economic recovery.
3) Asset quality: In banking, asset quality is of prime importance and looking only at profitability is not enough. Profits is not the right criterion to look for a good bank; one should rather look at the balance sheet. For e.g. Vijaya Bank. For FY10, it reported a profit of Rs 502 Cr, or Rs 240 Cr higher than the previous year's profit of Rs 262 Cr. Thus, its profit almost grew by 92 %. But, at the same time, its net NPA also grew by Rs 289 Cr.
The Bank should reduce net profit by increase in net NPA to get the real profit figure because the bank is not sure whether it will recover NPAs. Also, from September 2010, banks will have to provide for 70 % of gross NPA, which will dent profits significantly for banks not making sufficient provisioning at this stage.
4) Net interest margin (NIM):It is a measure of the bank's profitability, and is calculated as net interest income (interest income minus interest expenses) divided by interest yielding assets. This checks the bank's ability to price loans at higher rates, which is also function of bank's ability to mobilise low cost deposits -- current account and saving account (CASA). The higher the CASA ratio, the better it is. Also, as we are moving into higher rate scenario, CASA will become even more important. Since as interest rates go up, the banks with the highest CASA account will perform the best.
5) Other income: There are two big components of other income: fee income and treasury income. Although growth in fee income can be predicted somewhat, treasury income is relatively volatile. It depends on the wider interest rates situation in the economy, and is also affected by various factors like the monetary policy and government borrowing. As banks in India are required to keep 25 % of their demand and time liability in government securities, the overall effects of bond price movement can only be managed a little.
6) The road ahead:
Unanimous projections: The fiscal year 2010 wasn't too good for the banking industry in terms of loan disbursal. It remained subdued for most of this period, even as growth in credit fell to single digits at the end of October 2009. But later, as economic activity picked up, credit growth accelerated to around 17 % at the end of the financial year. Analysts expect it to remain robust. The offtake is once again expected to come from the infrastructure space, which, after a lull, has started witnessing higher activity.
Banks have raised capital in the previous year. Further, the government's decision to infuse capital into some banks would increase their limit for infrastructure lending.
7) Treasury Tricks: When the RBI followed the policy of lower interest rates to bring growth on track, the yield on government bonds came down. As a result, banks made huge profits on bond portfolios.
However, that trend has reversed now. The yields have risen significantly, with impacts already visible on banks' result for the March 2009 quarter. Most banks have suffered losses on bond portfolios.
Analysts believe that in the coming quarters, too, the bond yield will remain high and it would be difficult for banks to show treasury gains. But yields are not expected to harden too much from here on.
Economists expect yields on 10-year government paper to move at most to 8.5 % from the current 7.8 %. So, major negative surprises can be ruled out. Also if the government raises the FII limit in G-secs, as reported by the financial media, greater demand will raise their prices, thereby restricting the rise in yield.
8) Maintaining Margins: The net interest margin rose in FY10. One of the causes behind this rise was the high proportion of low-cost CASA deposits in the overall deposit base. As rates on term deposits were low, it became less attractive, and the share of CASA increased.
However, as term deposit rates have started to rise again, banks will face difficulty in maintaining the CASA level, even as pressure might be compounded by the lag that exists in adjustment of lending and deposits rates. The previous interest rate cycle was testimony to the hypothesis that lending rates, particularly in the case of Indian banks, react with a two or three quarter lag, compared to deposit rates. We expect this lag, coupled with an increase in savings rates, to exert pressure on margins in FY11.
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