Banking funds to gain from demonetisation

Robust performance to continue due to Casa windfall, loan growth and rural growth

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Even if you are not feeling particularly well disposed towards your bank at present, don't let that affect your investment decisions. Banking sector funds have clocked an average return of 15.42 per cent over the past one year. After some short-term hiccups in the wake of demonetisation, they are expected to continue to do well.

The first positive impact of demonetisation on banks will be an improvement in their CASA (current account savings accounts) ratio. As liquidity improves and cost of funding drops, many banks will lower their lending rates, as Axis Bank has already done. "Over time this will reflect in an improved credit-to-deposit ratio of banks," says Sunil Subramaniam, chief executive officer, Sundaram Mutual Fund.

Second, as cash circulating within the economy drops, consumption may be hit, which may get reflected in lower inflation. GDP growth may also falter for a few quarters. Experts expect the central bank to cut the repo rate by 50 basis points over the next six months. Banks hold a lot of government securities on their books. "When interest rates fall, banks will enjoy capital gains on the mark-to-market portion of their G-Sec portfolios," says Subramaniam.

In rural and semi-urban areas, a lot of money is flowing into Jan Dhan accounts. As a larger part of the rural population develops a track record with banks, the latter will be able to market their loans to them for funding large-ticket discretionary purchases. Also, more people may shift from informal channels of borrowing, such as moneylenders, to the formal banking system.

Next, let us turn to the prospects of the major sub-segments that banking funds invest in. The corporate segment's prospects are improving with the ongoing turnaround in the infrastructure sector, where stuck projects are moving now. Rising commodity prices in the international markets is another positive as commodity producers account for 5-6 per cent of the banking sector's loan book. However, as Amit Premchandani, co-fund manager, UTI Banking Sector Fund says: "Loan demand is likely to remain sluggish on the corporate side given low sanctions over past three years."

The NBFC (non-banking financial companies) sector has been a strong contributor to the performance of banking funds in the recent past, with the markets turning bullish on rural-focused NBFCs after a good monsoon. "It may be difficult for NBFCs to show similar returns, given their above average valuations, high expectations and the pressure on the cash economy," says Premchandani.

The retail banking segment has been on a strong wicket for the past four-five years, as the availability of credit scores has made retail lending less risky, and expanded the market. "With household debt-to-GDP ratio in India still much below emerging market norms, this segment should continue to grow," says Vinay Sharma, fund manager, ICICI Prudential Banking and Financial Services Fund.

Smaller segments like insurance, mutual funds, securities companies, etc should also continue to perform so long as the Indian economy, and hence markets, perform.

One risk to the banking sector could arise from a global shock. Within India, loan against property has seen fast growth, raising some concern.

When investing in a banking sector fund, remember that this sector already has a large presence in the portfolios of the diversified-equity funds you own. Mumbai-based financial planner Arnav Pandya suggests that your exposure to banking sector funds shouldn't exceed 5-10 per cent of your equity portfolio. Sharma advises choosing a fund that has shown long-term consistency and is less volatile. Premchandani suggests avoiding funds whose portfolios are concentrated in favour of NBFCs, and those that have bet on illiquid stocks.

READ OUR FULL COVERAGE ON THE MODI GOVT'S DEMONETISATION MOVE