Dr. Raghuram Rajan may have just spoilt a bank stocks party. The 1st April 2014 policy of the RBI has nothing positive for banks in the near future, though in the longer term the central bank is creating strong conditions for a vibrant banking system.
Bank stocks have rallied sharply in the first three months of calendar year 2014, with the BSE Bankex gaining by close to 12%. Bank stocks have rallied across the board with PSU banks such as SBI, PNB and BOB rallying by 9%, 17% and 10% respectively while private sector banks such as ICICI Bank, HDFC Bank and Axis Bank rallying by around 13% each. The reason for bank stocks rally has largely been on the back of a Modi led NDA creating conditions for economic growth that benefits the banking sector.
Table 1: Banking Sector Price Movements
Banks, especially the PSU banks are reeling under Non Performing Assets (NPA) that have grown at a CAGR of over 25% over the last five years. RBI is clear that banks should adopt stringent NPA monitoring systems and work towards finalizing a solution to the problem with the defaulter as well as other consortium lenders. RBI is frowning on the growth of restructured assets (a polite form of NPA that does not show up in the balance sheet) that has grown at a CAGR of over 40% over the last five years.
Banks will have less leeway to hide NPAs under restructured assets.
On the monetary front, RBI has made it clear that it will not hike Repo rates in the near future but there is no question of lowering the repo rates until the CPI inflation trends to levels of 8% in 2015 and 6% in 2016. No government pressure will force the RBI to relook at the Repo rate even at the cost of economic growth. Banks will not have much of room to grow NIIs (Net Interest Income) margins given that cost of funds will stay high.
The central banks is also moving away from lending guaranteed funds at repo rate under the LAF (Liquidity Adjustment Facility) and is moving towards term repos that are market determined. Banks treasury income may be hit if cost of funds is not stable and there is less chance of arbitrage.
Banks will have to hope for growth revival to lower stressed assets in their books as well as to grow credit. RBI growth projections for 2014-15 is in a 5% to 6% range with more downside risks given factors of El Nino, inflation, Fed taper and sluggish global economic growth. Banks may not see much growth this fiscal until the new government policies come into effect.
Long term prospects for banks are good
In the short term, RBI may have spoilt a bank stocks rally but in the long term if RBI is able to contain inflation, improve strength of the banking system, have a robust bank license policy and provide confidence to FIIs on the Rupee, banks stocks will gain. Hence short term investors would suffer from bank stocks volatility while long term investors would gain from fundamental strength to the banking system.