Opportunities for traders in banking space

For the past two-and-a-half years, the Reserve Bank of India’s focus has been on a tight monetary policy. That is part of its mandate. However, the central bank also has the duty of overseeing the banking sector. The implementation of Basel-III norms from January 2013 will highlight that role. Over the next five years, the Indian banking sector will have to raise huge sums in both equity and debt in order to meet new and more stringent capitalisation norms.

This means a lot of bank paper hitting the initial public offering (IPO) market. It will be a difficult task to manage for several reasons. At the moment, growth is slow and many loans are sticky with a stream of large restructuring requests. This makes banks, especially PSU banks, look unattractive investment prospects at the moment.

As and when the economy goes into recovery mode, the sticky loan situation will improve. But the demand for credit will also rise as businesses go into expansion mode and consumption demand rises. Since banking norms are tied to outstanding credit, this will mean that banks will need to raise even larger sums as the economy moves into a boom phase.

The government will have to take hard decisions about maintaining its equity stake (about 58 per cent overall) in the public-sector unit (PSU) banks because it may not find it easy to pump the required amounts into the banking system. Individual banks will have to take tricky decisions about the timing of their fund-raising and the structures they adopt in tapping equity and debt markets.

But the central bank will have to manage the overall monetary environment to let this process of recapitalisation proceed smoothly. This will exert a huge influence on monetary policy over the next five years.

That is a pretty long timeframe. One can more or less guarantee that the macro-economy will go through at one full boom-bust cycle while the Basel-III recapitalisation takes place. It is an unprecedented situation because of the quanta of funding required as well as the length of the time-period and because every bank, more or less, will have to go to the market.

How can a trader exploit this? There can only be signposts. The market is likely to respond in exaggerated fashion to changes in bank balance-sheets and especially in NPA and provisioning situations. So, efforts will be made to prop up valuations, perhaps by window-dressing. However, whenever a bank announces an IPO, the impending equity dilution is likely to cause a drop in the price. It's impossible to predict directional trends over such long periods. But a rise in volatility in a sector which is already high-beta should provide rich opportunities to traders with flexible outlooks.

The author is a technical and equity analyst