India's banking sector will see strong growth

Banking stocks have declined sharply in recent weeks. While the Sensex has declined from its high of February The BSE Bankex has fallen by 14%, the BSE Bankex has fallen by 18%.

That is to be expected. Bank stocks are considered riskier than the broader market, which is why they typically trade at a discount of 15-20% to the market multiple. But once the present correction has run its course, expect bank stocks to revive strongly.That is because the outlook for profit growth in the banking sector remains strong, as I argue in my recent column in ET.

Many analysts think credit growth with decelerate strongly because retail credit will heavily impacted by rising interest rates. I think they are wrong, for reasons I spell out in my column.

Analysts also think that banks' net interest margin, the difference between interest income and interest expense as a proportion of assets, will decline sharply with rising interest rates. That is because banks are heavily dependent on short-term deposits. Deposit costs will go up but banks won't be able to pass on these to borrowers.

This is only partly true because in retail loans, the floating rate component of loans is quite high today- many banks offer home loans with a mix of 50:50 fixed and floating rates. But, even if the spread on loans is squeezed, banks stand to gain because the proportion of loans in assets is rising relative to government securities. Rates on loans are typically higher than on government securities.so the overall yield on the portfolio of assets can be expected to go up.

Then, banks are seeing a sharp rise in fee income as they are able to cross-sell mutual fund, insurance and other products.

Overall, banks will see high loan growth with the net interest margin being maintained or decreasing narrowly. Revenues will be boosted by fee income. Non-performing assets will continue to decline or at least will not increase. Intermediation costs will decline as banks continue to scale up. All this translates into robust profit growth. No surprise, there. Banks are a play on the economy. If you believe the India story, you must believe the banking story.