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Banking sector feels the pinch of economic slowdown

Recent developments in the economy have lowered the valuation of the banking sector; says an updated report prepared by SBI Capital Markets Limited, a subsidiary of the State Bank of India.

The report prepared by the Securities Research Department of SBI Caps said that the banking sector index has underperformed the Sensex of the Bombay Stock Exchange since July 1997 mainly due to the slowdown in the economy, southeast Asian crisis, foreign exchange volatility and declining export growth.

The sanctions, post-nuclear tests and Moody's downgrade of India's sovereign rating led to uncertainty about the economy and the prospects of the banking sector, the report stated.

However, after measures introduced by the Reserve Bank of India in January 1998, the valuation of the banking sector improved as the banks reported good results in the first quarter of the year.

The report made a comparative study between price to book value ratio and price to assets ratio for valuation of banks besides the price of earnings ratio and suggested that the valuations of the sector would remain depressed on account of pressure on margins, deceleration in economic growth and fears of increasing non-performing assets.

While the new private banks command a higher valuation in the market, the public sector banks with their relatively lower return on average equity are placed lower in valuation list.

The SBI Caps report, which expected bank deposits and credit to grow by 18 and 16 per cent respectively in 1998-99, said that increased competition would force banks to work with lower margins and hence the thrust would be on improved efficiency, better risk management and larger volume of business in future.

Discussing future financial sector reforms, the report said that in the next few years, the financial system would become more complex as the forces of competition gained momentum and the financial markets acquire greater width and depth.

The policy environment in the next stage of reforms will have accent on greater operational flexibility as well as greater prudential regulation and supervision along with improvement in the organisational effectiveness of banks.

In terms of financial performance during the year 1997-98, the growth in banks profit during the year was mainly on account of trading profits and write back of excess investment depreciation provision. Growth in net interest income was marginal because of cut in prime lending rates and subdued credit offtake for most part of the year.

Also high growth in other income on account of sale of investments and foreign exchange income have boosted income of the banks. Many public sector banks boosted their profits by taking the excess provision for investment depreciation to the profit and loss statement.

UNI