Banking stocks rally on better earnings outlook; room seen for upside

Banking stocks have been laggards at the bourses in the market rally due to expectations of severe asset quality pressure led by Covid-19-induced disruptions.
On Friday, the BSE Bankex ended with gains of about 4 per cent, the most since March 13. This was also the highest close for the index since that day.

The benchmark Sensex rose 0.9 per cent, or 353 points, to end at 39467.31, its highest close since February 27, The Nifty50 index added 0.83 per cent to end at 11,655. Both indices logged their sixth consecutive day of gain.

Four of the five top Sensex gainers were banking stocks, led by IndusInd Bank, which rose 8.4 per cent, followed by Axis Bank and ICICI Bank, which rose 7.7 per cent and 4.4 per cent, respectively. The top five banking stocks made a 300-point contribution to Sensex gains.

Experts believe banks’ earnings outlook has improved sharply from March and April.

Banking stocks were laggards in the recent market rally because of expectations of severe asset quality pressure thanks to Covid-19-led disruptions. While other top companies have seen their stock prices reach record highs, banking shares are still down between 10 per cent and 50 per cent on a year-to-date basis.
However, UBS in a note said subsiding tail risks and recent underperformance creates room for upside in banking stocks. “Government and Reserve Bank of India (RBI) relief measures have reduced tail risks in the banking system. We believe NPL (non-performing loan or bad loan) risks are lower than our earlier estimates and new rules would give banks more time to build provisions,” it said, adding that the downside risks for the sector are limited.


Thanks to this and better net interest margin outlook, the foreign brokerage also revised its FY21 earnings estimated by about 115 per cent for major banks like State Bank of India, Axis Bank, ICICI Bank, IndusInd Bank, HDFC Bank and Kotak Mahindra Bank.

Sanjiv Bhasin, director at IIFL Securities, also says, “expectations of improvement in asset quality with regulatory support, better credit growth and lower valuations are supporting the rally in banking stocks.” He expects these stocks to outperform and sees the Nifty Bank index reaching the 27,000 mark by December, implying a further 10 per cent upside.
Additionally, analysts said rising inflation might put an end to the central bank’s interest rate-cutting cycle and boost banks’ prospects. “Banks will come into focus in this re-inflation scenario. It will increase their net interest margin and is good from a business point of view. They make up a large part of the index and will lead the rally,” Sameer Kalra, strategist, Target Investing said to Bloomberg.

The recent capital infusion in banks, which some analysts believe is helping reduce balance sheet risk, is driving investor interest toward these stocks.

Rohan Madora, analyst at Equirus Securities, says: “Stricter restructuring guidelines with time limitations will ensure only pandemic impacted cases will be restructured. Additionally, pace of economic recovery will be a key monitorable. Overall, we believe slippage out of fresh restructured pool would be lower than the previous cycle.” The jury is out on this.

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