 "D-Street more financialised than Wall Street")
The financial sector has become more important in the Indian stock market than in the US, the country with the world's most developed financial services sector.
In 2014-15, for instance, the Indian financial sector's contribution to the total profits of the S&P BSE 500 (BSE 500) companies reached an all-time high of 31 per cent, higher than the sector's share of corporate profitability in the US. In the last financial year, the US financial sector accounted for only 20.6 per cent of the combined net profits of the S&P 500 companies (see chart).
Even the weight of the financial sector in the BSE 500 at 21 per cent is higher than 16 per cent in the S&P 500. The gap, however, is not as high as in the case of profit share.
The data suggest while the 2008 crisis hit the financial sector in the US, reducing its relative importance; it did the opposite in India. Shares of financial sector in the BSE 500 companies' combined profits is up by over 12 percentage points since 2007-08. During the same period, financials' profit-share in the S&P 500 companies declined by over six percentage points.
The analysis is based on the past 20 years' financial data of the companies that are part of the BSE 500 index in India and the S&P 500 index in the US. The net profits for Indian companies are adjusted for exceptional items.
In all banks, non-banking financial companies (NBFCs) and brokerages have accounted for 64 per cent of the incremental growth in the BSE 500 companies' net profits in the past five years. Financials accounted for 26 per cent of the S&P 500 companies' incremental profits.
In the Indian context, experts attribute this to the poor performance of industrial companies after 2008 financial crisis and faster growth of private sector banks and NBFCs, which flourished by lending to the retail sector.
"There has been a virtual collapse in corporate earnings in cyclical sectors such as infrastructure and manufacturing, while most parts of the financial sector continue to do well. This has amplified the importance of the financial sector in India," said the head of research at a foreign brokerage on condition of anonymity.
He also flagged the issue that Indian banks were overstating their profits, unlike their US counterparts, which were under tough regulatory scrutiny after 2008. "Many banks in India are overstating their profits and their numbers do not truly reflect the financial stress in the broader economy," he added.
"Banks enjoy considerable flexibility in juggling their net profits by reducing or increasing the provisioning ratio in a particular year. Many banks, especially government owned, have pushed up their profitability in recent years by reducing their provision coverage ratio," said Dhananjay Sinha, head of institutional equity at Emkay Global Financial Services. The provision coverage ratio reflects the proportion of stressed assets and bad loans that banks have provided for in their profit and loss accounts in a particular period.
The financial sector's contribution to total corporate revenues has remained stagnant at around 20 per cent while its share in salaries has declined over the years. Financials accounted for a fifth of the total salary bill of the BSE 500 companies in 2014-15, down from nearly 35 per cent around 15 years ago and around a quarter in 2006-07. This also indicates that higher productivity has partly helped boost profits of India's financial sector.
However, Dalal Street's growing reliance on the financial sector to drive corporate earnings worries many analysts. "Corporate profitability should be broad-based, with fair contribution from all sectors in the economy. But the poor performance of the manufacturing, industrial and non-financial service sectors has made the market depend overly on banks and finance companies to drive earnings. I am not sure how long this will last," said Santosh Singh, head of research at Haitong Securities.
Others said it raised the risk of a contagion in the event of a financial shock. "If the financial market becomes volatile, hitting profitability of banks, it will have a disproportionate impact on the broader market," Sinha said.
In 2014-15, for instance, the Indian financial sector's contribution to the total profits of the S&P BSE 500 (BSE 500) companies reached an all-time high of 31 per cent, higher than the sector's share of corporate profitability in the US. In the last financial year, the US financial sector accounted for only 20.6 per cent of the combined net profits of the S&P 500 companies (see chart).
Even the weight of the financial sector in the BSE 500 at 21 per cent is higher than 16 per cent in the S&P 500. The gap, however, is not as high as in the case of profit share.
The data suggest while the 2008 crisis hit the financial sector in the US, reducing its relative importance; it did the opposite in India. Shares of financial sector in the BSE 500 companies' combined profits is up by over 12 percentage points since 2007-08. During the same period, financials' profit-share in the S&P 500 companies declined by over six percentage points.
The analysis is based on the past 20 years' financial data of the companies that are part of the BSE 500 index in India and the S&P 500 index in the US. The net profits for Indian companies are adjusted for exceptional items.
In all banks, non-banking financial companies (NBFCs) and brokerages have accounted for 64 per cent of the incremental growth in the BSE 500 companies' net profits in the past five years. Financials accounted for 26 per cent of the S&P 500 companies' incremental profits.
In the Indian context, experts attribute this to the poor performance of industrial companies after 2008 financial crisis and faster growth of private sector banks and NBFCs, which flourished by lending to the retail sector.
"There has been a virtual collapse in corporate earnings in cyclical sectors such as infrastructure and manufacturing, while most parts of the financial sector continue to do well. This has amplified the importance of the financial sector in India," said the head of research at a foreign brokerage on condition of anonymity.
He also flagged the issue that Indian banks were overstating their profits, unlike their US counterparts, which were under tough regulatory scrutiny after 2008. "Many banks in India are overstating their profits and their numbers do not truly reflect the financial stress in the broader economy," he added.
"Banks enjoy considerable flexibility in juggling their net profits by reducing or increasing the provisioning ratio in a particular year. Many banks, especially government owned, have pushed up their profitability in recent years by reducing their provision coverage ratio," said Dhananjay Sinha, head of institutional equity at Emkay Global Financial Services. The provision coverage ratio reflects the proportion of stressed assets and bad loans that banks have provided for in their profit and loss accounts in a particular period.
The financial sector's contribution to total corporate revenues has remained stagnant at around 20 per cent while its share in salaries has declined over the years. Financials accounted for a fifth of the total salary bill of the BSE 500 companies in 2014-15, down from nearly 35 per cent around 15 years ago and around a quarter in 2006-07. This also indicates that higher productivity has partly helped boost profits of India's financial sector.
However, Dalal Street's growing reliance on the financial sector to drive corporate earnings worries many analysts. "Corporate profitability should be broad-based, with fair contribution from all sectors in the economy. But the poor performance of the manufacturing, industrial and non-financial service sectors has made the market depend overly on banks and finance companies to drive earnings. I am not sure how long this will last," said Santosh Singh, head of research at Haitong Securities.
Others said it raised the risk of a contagion in the event of a financial shock. "If the financial market becomes volatile, hitting profitability of banks, it will have a disproportionate impact on the broader market," Sinha said.