Nifty 50 and Sensex ended at new record highs on Wednesday. The Indian stock market indices are heavily weighed by financial stocks, dictating their movement often.
While analysts believe that the sector, especially banks, are set to see re-rating and earnings upgrades in 2021, RBI warns of a disconnect between the equity market and real economic activity.
Banks fared COVID-19 better than expectations, say analysts
Analysts at Morgan Stanley said in a recent note that private lenders strengthened their capital, built excess provisions, improved liquidity positions, and increased digital adoption to come out strong from the COVID-19 crisis. A combination of these factors will help them gain rapid market share and materially lower cost to income ratios over the next few years, the note added.
Similarly, American brokerage BofA believes that the actual asset quality concerns in the calendar year 2020 turned out to be "much more limited than worried" possibly due to the banks' already risk-averse approach over a couple of years leading into the pandemic.
It added that this means investors can now expect the focus to gradually shift from asset quality to growth in 2021.
Investors bet on banks on expectation of growth as the economy recovers
Inflows from foreign investors into the Indian equity markets, re-rating, increased digital banking adoption and expectations of earnings upgrade have improved interest for banking stocks among investors.
Analysts at BofA Securities in a recent report said that they have "turned positive" on the Indian banking sector, and have upgraded Axis Bank, IndusInd Bank, and State Bank of India (SBI) on a "surprisingly" resilient asset quality outlook, and reasonable valuations.
CLSA remains optimistic on the sector on the expectation of benign credit cycle for retail and corporate sector. It sees further legs for re-rating in ICICI Bank, SBI, and Axis Bank.
As for PSBs, the mergers and subsequent measures taken to regulate the institutions have aided the rerating. Moreover, public sector banks (PSBs) make for the majority of the market share in India, which means that a pick up in the economy will also help also aid their growth.
In his foreword to RBI's biannual Financial Stability Report (FSR), released earlier this month, RBI governor Shaktikanta Das flagged the growing disconnect between equity markets and real economic activity and warning that the ‘stretched valuations of financial assets' threaten overall financial stability.
"The disconnect between certain segments of financial markets and the real economy has been accentuating in recent times, both globally and in India," he said.
The pandemic could also trigger balance sheet impairments and capital shortfalls, especially as regulatory reliefs are rolled back, Das cautioned.
"Congenial liquidity and financing conditions have shored up the financial parameters of banks, but it is recognised that the available accounting numbers obscure a true recognition of stress," Das wrote.
As per the FSR, the gross non-performing assets (GNPA) and net NPA (NNPA) ratios of banks fell to 7.5% and 2.1%, respectively, by September 2020.
However, RBI warned that the withdrawal of pandemic-triggered reliefs could see a jump in bad loans at lenders.
"The improvements were aided significantly by regulatory dispensations extended in response to the COVID-19 pandemic. Macro-stress tests for credit risk show that SCBs' GNPA ratio may increase from 7.5% in September 2020 to 13.5% by September 2021 under the baseline scenario," RBI observed.
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About the author
Olga Robert is an M.Com graduate covering equity markets and personal finance for nearly three years. Her interests include tax planning, equities, DIY personal finance management and government schemes.