Banking on banks may not be great idea

Banking sector has ~25% weightage in the benchmark Nifty50 index. Consequently, banking stocks invariably find a prominent place in the portfolios of most funds and large HI portfolios. The overall performance of equity investment portfolios thus materially depends on the performance of banking stocks.

In the post global financial crisis (GFC) period, despite all the challenges, the Bank Nifty index has notably outperformed the Nifty50. However, in the past six years, BankNifty has broadly lagged the performance of Nifty50. This long phase of underperformance needs to be examined in some depth by investors.

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In my view, the tailwinds that drove the sector’s re-rating post GFC and then again over 2019–2023 are either exhausted or reversing. Meanwhile, fresh headwinds are emerging — on costs, margins, regulations, and the very nature of banking as a differentiated business. Put together, these factors build a case that Bank Nifty, and banking stocks broadly, may underperform the Nifty 50 over the next twelve months.

In particular, the following factors indicate that the performance of banking sector might continue to lag in the next 6 to 12 months:

·         Widening credit-deposit growth gap

·         Sticky cost to income ratios

·         Asset quality close to peak

·         NIMs peaking

·         Regulator squeezing fee income

·         Banking products getting commoditized, driving away valuation premium

I will share my views on these key concerns tomorrow.