Banks’ unique position that allows access to low-cost capital makes them a safe investment option, but risk-averse
When it comes to investing in Indian stocks, names like TCS, HUL, Britannia, Nestle and ITC, to name a few, generate constant interest. However, interestingly, neither the FMCG industry nor the IT sector has outperformed the Nifty 50 index in the past decade, but the banking sector has outperformed. As seen in the attached graph, the Nifty Bank index has largely outperformed the Nifty 50 since 2008.
According to RBI, the number of scheduled commercial Indian banks includes 22 private sector banks, 11 small finance banks and 12 public sector banks. In contrast, the US, which has only a third of our population, has a total of 2,108 banks. Additionally, it should be noted that the top five banks in India dominate the share of total deposits and transactions.
concentration risk
The concentration of significant market share in the hands of a few leads to behavior where independent firms can act in harmony to ensure profit maximization. A significant barrier to entry in the industry pushes such behavior.
RBI has strict rules and is very conservative in distributing commercial banking licenses on a large scale, as can be seen from the sparse number of banks. These big banks keep the financial system sound by lending to each other and also by taking loans.
So, as American economist Irving Fisher put it, a single bank collapse will wreak havoc in the financial system, as has been seen in the US on several occasions. The RBI is aware of this and will put in a lot of effort to ensure that no bank collapses, thereby creating an additional layer of protection for banks in the form of investments. The bailout of a troubled bank has been demonstrated with great certainty if one can recall the mess of Yes Bank.
The most important of the many benefits that banks accrue is access to big finance from their banking peers and from the RBI, which acts as the lender of last resort.
‘Low risk bets’
This puts banks in a unique position to obtain cheap capital, as most of their asset books are liquid and are therefore considered low risk. They have access to low-cost capital through the ability to open current accounts and savings accounts. Fractional reserve banking – in which only a fraction of bank deposits are backed by actual cash and available for withdrawal, to help the economy expand by freeing up capital for lending – allowing them to create wealth temporarily gives.
It is not only the markets that recognize the dominance of banks, but NBFCs also want to enter the sector owing to the better advantage of access to low cost capital. Capital First, an NBFC, merged with IDFC Bank to form the merged entity IDFC First Bank on December 18, 2018.
At the time of merger, their loan book stood at ₹1.03 lakh crore. Capital First effectively accessed low-cost capital to further expand its existing retail customer base. It was also a way to circumvent the requirement of holding a banking license. There is also word in the air of another NBFC following this route – Clix Capital is said to be in talks with Suryoday Small Finance Bank, to eventually join this elite group of banks, which are looking for candidates in the sector. uncovers attraction to. The comparison of the graph shows the dominance of banks as the Nifty 50 also includes banking stocks. This means that the performance of banks has clearly outperformed the general market by a much more significant margin. It also highlights an important point – the market favors businesses with steady cash flow flows in the long run.
Still, it is prudent to recognize that the banking business is resilient, but not immune to threats. This banding of institutions in the banking system may end in future for a number of reasons, the major ones being the innovative and cutting edge fintech companies making significant inroads into India.
American landscape different
Small finance banks, which offer far more competitive rates, bring an element of competition and healthy behavior to the table. The final and much-awaited liberalization of the banking sector may also end the race of dreams. The US has liberalized its banking sector, resulting in a large number of players playing there. While most of the market share still belongs to the 10 largest banks, it is clear from the market performance that the banking sector (which underperformed the S&P 500) is nowhere near as dominant in India. Despite these threats, banks will continue to reap benefits that no other industry can, at least for the time being.
(Anand Srinivasan is a consultant. Saswatha Swaminathan is a research associate at Ionian Investment Services)
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