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SPECIAL REPORT

Though bank stocks have recovered after the carnage last week, investors should follow a stock-specific approach.

When the Reserve Bank of India (RBI) increased the cash reserve ratio (CRR) requirement for banks by 50 basis points, the BSE Bankex tanked by 6.5 per cent on Monday and another 3.3 per cent on Tuesday.

However, over the next three days, the Bankex gained 4 per cent, though it ended the week down by 3 per cent over the previous week.

A part of the reason is that the overall market started improving from Wednesday. Some fund managers and analysts explain the sell-off in the first two trading sessions as a knee-jerk reaction to the CRR hike and they maintain their positive outlook for the banking sector.

Says A Balasubramanian, chief investment officer, Birla Mutual Fund, "The medium to long term outlook is positive as there is still lot of value in many of the banking stocks."

But that does not mean investors will do well with any banking stock. While private sector banks have moved up substantially, analysts say there may be some upside in stocks like Bank of Baroda, Allahabad Bank, Andhra Bank, State Bank of India and Punjab National Bank.

Stoking growth
RBI increased the cash reserve ratio (CRR)"�the money that banks keep with the RBI in cash"�from 5 per cent to 5.5 per cent in two tranches of 25 bps each in December 2006 and January 2007.

The hike, which comes after a gap of almost two years, will suck Rs 13,500 crore out of the system. The central bank's rationale behind the move is to curb the unabated growth in money supply and credit which grew at 19 per cent and 30 per cent year on year as on November 24, "�above RBI's targeted limits "�after a similar growth last year.

Inflation (wholesale price index) is also heading towards 5.5 per cent"�the cap set by RBI for 2006-07 and consumer price index (CPI) over 7 per cent is inching up further. Bankers believe that margins will be impacted to the extent of the interest foregone and may also push up interest rates, especially deposit rates.

Says, M V Nair, chairman and managing director, Union Bank of India, "If you consider the yield on funds of 8.5 per cent, then over Rs 1000 crore per annum will be the revenue loss to the banking system as a whole, which would have been otherwise earned if invested in bonds or given as loans."

Analysts estimate net interest margin (NIMs) to decline marginally by 4-5 basis points. However, Rupa Rege, chief economist, Bank of Baroda, has a contrarian view as she thinks that margins will be protected as banks will pass on any rise in cost of funds to consumers.

Adds Balasubramanium, "Profitability is not expected to be affected much as a hike of 50 basis points is not very significant compared to balance sheet of a bank."

Rate blues
After the CRR hike, industry experts expect interest rates to go up. Cost of deposits are expected to move up by 50 basis points but only over a period of time as deposits get renewed, which SBI has effected last week.

ICICI Bank has also gone ahead with raising its lending and deposit rates. And there is strong probability that others are expected to follow suit.

Overall, the prime lending rate (PLR) is not expected to rise much and only the gap between the PLR and sub-PLR (the rate that top corporates pay or even home loan borrowers) of 150-300 basis points is expected to narrow unless in the extreme cases where banks may be forced to raise even the PLRs.

While the credit growth should moderate, low yielding assets like homes loans and bulk corporate loans are expected to be hit the most.

However, a fund manager at a leading mutual fund believes that a 50 basis point hike is unlikely to impact demand for credit, which is likely to remain strong and banks can pass on any rise in costs.

What's in store?
An analyst from a leading broking firm is positive on banks like SBI, PNB and Andhra Bank, which have decent low-cost deposit base and have successfully curtailed credit growth to 20-25 per cent.

Sejal Doshi, CEO, Finquest Securities also advises investors to be stock specific despite being positive about the sector. He is positive on Allahabad Bank mainly due to its cheap valuations on a forward adjusted book value.

On the other hand, Ajit Dange, analyst, UTI Securities feels that some of the frontline banking stocks, especially in private sector space, have to correct more if they have to quote at attractive valuations.

He expects upside in Bank of Baroda, Syndicate Bank and Corporation Bank at current levels, especially after the recent correction.