BANKS SEE GOOD FUTURE...!!!

Here's why banks will rally againBroking firm Jefferies says Indian financial system is now flooded with the kind of liquidity witnessed in 2005-07 and 2009-10Shishir Asthana  |  Mumbai  

September 22, 2014 Last Updated at 18:22 IST

Recently announced non-food credit and GDP data suggested that India is on the path of a credit-less growth. While some businesses are starving for low-cost funds, banks are flushed with liquidity, prompting them to cut down interest rates on deposits.

None of this seems to bother analysts who continue to remain bullish on the sector. Morgan Stanley in a report titled ‘Correction: The upcoming second leg of bank rallies’ says Indian banks have rallied nearly 42% on a year-to-date basis mainly on account of growing confidence in the Indian economy which would in-turn improve asset quality. But the next leg of stock performance will be fundamental driven asloan growth picks up.

Morgan Stanley says that historically bank stocks have rallied in two cycles. Indian banks are currently in the transition phase between the two cycles. The first leg is driven by expectations around better asset quality. The second and more sustained leg is driven by a loan growth pick-up, which sets an earnings upgrade cycle in motion. Banks now have the liquidity to fuel the next round of growth.
Broking firm Jefferies says Indian financial system is now flooded with the kind of liquidity witnessed in 2005-07 and 2009-10. Ample liquidity and lower overnight rates are also showing up in falling risk spreads - BBB-minus bonds are now at their lowest levels. Both commercial paper and certificate of deposit markets are showing signs of life and no liquidity stress.
Several banks have cut home loan rates. If allowed, this trend will be seen across products and in banks' Base Rate sooner than later. Banks, it seems, are waiting for a signal from the central bank to announce a rate cut. As reported in Business Standard in a recent interaction between members of the banking community and RBI, lenders have asked the central bank to cut repo rate to spur loan growth.

RBI Governor has however ruled out any reduction in interest rate in the month-end monetary policy announcement. Analysts are expecting a rate cut from the central bank to take place sometime in 2015. A Bank of America Merrill Lynch report says that a supportive Balance of Payment situation and a stable rupee – though on account of low gold and oil prices should see the central bank reducing interest rates by around 75 basis points in 2015.

Banks however, are now facing a problem of plenty. Liquidity is at such high levels that the amount the banking system needs to borrow from the Central Bank through Liquidity Adjustment Facility (LAF) and other windows (term repos, Marginal Standing Facility or MSF) has declined, reaching near zero, says Jefferies. Without a significant RBI intervention, it is quite possible that the net liquidity balances slip back in to the negative territory or a surplus.

Morgan Stanley says that a capex cycle is needed for loan growth to go back to more than 20 per cent levels, from the current levels of less than 10 per cent. This looks tough in the near term and might happen over the next 1-2 years. However, Morgan Stanley feels retail to be strong and SME (small and medium enterprises) working capital demand to pick up – helping system loan growth to trend to 15% by FY15. This will drive the second leg of this rally.