Bull run in banking & financial sector to continue in 2008

The bankex, a representative of banking stocks in India, has significantly outperformed the BSE Sensex, the broad-based BSE 500 index and other sectoral indices in '07 for the first time in the past couple of years. It has offered a return of 60%, against the 45% return given by the Sensex last year. The bull run in banking and financial stocks is likely to continue in '08 and beyond.

BANKS

The impetus will come from domestic interest rates — the main concern for banks — which are expected to ease in the second half of '08, as the global interest rate cycle begins to turn around. Moreover, banks are trying to broaden their business base. Aggressive expansion on the international front, aided by a rapid growth in India's international trade, overseas mergers & acquisitions (M&As) and foreign capital inflows will strengthen banks' financials from current levels.

Indian banks are yet to tap their huge business potential. As of now, only one in three Indians has a bank account. If the domestic banking sector succeeds in bringing even half of the excluded population under the formal banking channel, it will open up the floodgates of stupendous growth. Many banks, including some in the private sector, have realised this and have initiated a process of setting up operations in semi-urban and rural areas.

Besides, investors can also expect to gain from an impending consolidation in the industry. Beginning April '09, foreign banks may be allowed to pick up stake in domestic banks, triggering a big round of M&As in the industry. State Bank of India (SBI), the largest PSU bank, has already initiated the merger process of its six associates. Other PSU banks are also expected to follow suit.

Looking at the future growth of Indian banks, investors can increase their exposure to this sector. Within the sector, besides the usual favourites like SBI, Punjab National Bank, HDFC Bank, ICICI Bank and Kotak Mahindra Bank, many small and medium plays including Canara Bank, Central Bank, Oriental Bank of Commerce and Bank of Baroda offer great value to investors against the backdrop of easing interest rates.

MUTUAL FUNDS
The domestic mutual fund industry is still at a nascent stage vis-à-vis the developed countries. However, the industry's growth in the past few years indicates its future potential. In the past seven years, the assets under management (AUM) of mutual funds have jumped by around six times to cross more than Rs 5 lakh crore by the end of the last calendar year.

The growth is attributed to the rising interest of Indian households in the stock market. Not surprisingly, the number of asset management companies is also increasing by the day. The industry has, however, only scratched the market surface, so far. Equity investments account for less than 7% of all financial savings of households in India. In a market like the US, the corresponding figure is above 50%. The industry's growth will be stupendous if it is able to capture even a quarter of India's household savings.

Personal disposable income in India is also growing in high double digits and the market regulator has now opened up a new growth avenue for the industry — real-estate mutual funds (called REITs) and short-selling of equities. The industry has also gained after RBI raised the overseas investment limit for the mutual fund industry to $5 billion.

In '08, pension funds expect to get a nod from the government to invest in equities via the mutual fund route. And given the large number of mega IPOs this year, ample IPO proceeds are expected to be parked by corporates in short-term debt mutual funds.

NBFCs
With all segments of the financial sector witnessing explosive growth, non-banking financial services companies can hardly afford to miss the action. The 11th Five-Year Plan is expected to lay a huge emphasis on infrastructure growth, with estimated investments to the tune of $320 billion. This will lead to a substantial surge in demand for project capital.

With banks being unable to meet the entire demand for long-term capital, the door remains wide opens for specialised institutions such as Power Finance Corporation, SREI Infrastructure Finance, IDBI, and soon-to-be-listed Rural Electrification Corporation, among others, to tap this opportunity.

Other growth segments include mortgage banking and commercial vehicle finance. Despite the recent surge in house-building, India faces a housing shortage of over 20 million, which can only be met through further expansion in the lending activities of mortgage banks such as HDFC, LIC Housing Finance and GIC Housing Finance, among others.

BROKERAGES
2008 is also expected to bring cheer to brokerages, which have been one of the biggest beneficiaries of the rise in market capitalisation and trading volumes. The growing retail participation in the equity market is evident from the growing number of demat accounts every year.

In the past four years, there has been an over 80% growth in the number of demat accounts from 67 lakhs in December '04 to more than 120 lakhs by the end of last year.

As trading volumes rise further, the trend is likely to continue in coming years. Having consolidated their brokering business, many large players are now diversifying into related activities including investment banking, merchant banking, and margin funding. This offers huge upside potential for investors willing to stay invested in these scrips for 3-4 years.