Asset quality uncertainty, weak credit growth take toll on banking funds

Banking funds have been the worst-performing equity category over the last three months even as markets have rallied over 19 per cent in this period.

The category has given less than 1 per cent returns over the same period.

Market experts attribute this weakness in performance to asset quality concerns, combined with lack of credit growth.

“The credit off-take has been weak. Extension of moratorium would delay the recognition of pain points in the system. As of now, there is uncertainty over the asset quality of the lenders,” said Deepak Jasani, head-retail research at HDFC Securities.

Analysts say banks have become risk-averse in their lending due to uncertainty cause by the coronavirus-induced lockdowns. This, along with a slowdown in business activity, has led to low credit growth even as banks are flush with liquidity.

Fund managers say that the actual asset quality trends would emerge clearly after the December quarter of the current financial year.

“Private sector banks and larger non-bank financial companies would be in a better position to deal with the challenges caused by the outbreak of Covid-19 pandemic,” said a fund manager.

“Public sector banks could see more pockets of asset quality stress,” he added.

The Reserve Bank of India (RBI), in its recent Financial Stability Report, pointed that the asset quality of banks is likely to deteriorate significantly in current financial year.

The RBI’s stress test pointed out that the gross non-performing assets (GNPA) ratio of banks is likely to rise from 8.5 per cent in March, 2020, to 12.5 per cent by March, 2021 in the baseline scenario.

But, if the economic situation worsens further, the GNPA ratio may spike to as much as 14.7 per cent in a ‘very severely stressed scenario’.

Experts caution investors from getting attracted to banking sector funds on the expectations of a sharp bounce-back.

“The sector may see a recovery, but it can be a long-drawn process. In the interim, investors can lose their conviction on such sectoral funds,” said Amol Joshi, founder of Plan Rupee Investment Services.

Banking funds have done well in the past as the sector has seen strong growth over the years. The sector has also seen its weight in benchmark index Nifty surge as much as 35 per cent over the years.

“With sector funds, timing becomes critical, which may not come easily to all investors. For instance, investors who had entered banking funds in 2017 would have made money, but they had not exited yet, their returns would have been heavily eroded,” Joshi added.

In 2017, banking sector funds were among the top-performing equity category with returns of over 38 per cent. In 2019 as well, the sectoral funds were among the top-performers with gains of 14.79 per cent.

However, in the current calendar year (year-to-date period), sectoral funds have seen nearly 33 per cent negative returns.