Indian Markets – Dutch Uncles

5 Parameters To Analyse Banking Stocks

Aakash Sharma — Mon, 11 Oct 2021 03:35:08 +0000

Investing in the stock markets is only as successful as your due diligence in conducting research and analysis before going forward with the investment. One of the most critical aspects of designing an investment strategy is determining which stocks are performing well along with the diversification of portfolios. This is where one of the historically strongest stocks come into the picture- the banking stocks.

Most retail investors have banking stocks in their portfolios. Banks and financial institutions have significant free floats that give investors a sense of security and profitability in the stock market. However, with limited access to credit in India, financial companies still have a long way to go. This is reflected in the expanding popularity of banking and financial stocks.

Yet, a bank stock’s credibility differs significantly from the review of everyday companies or traditional industrial stocks. Unlike non-financial corporations, where metrics such as working capital cycle, gross margin and leverage are essential to analyse, banking stocks need to be analysed using completely different parameters.

Reading bank statements and documents as part of the fundamental analysis can be a dexterous task. Too many numbers cause more confusion than a clear understanding. And that is what we are here to discuss. To analyse a bank’s monetary statements, one needs to know the following metrics.

Current Account Savings account (CASA) Ratio

The Current Account Savings (CASA) ratio is the ratio of total bank deposits in current and savings accounts to net deposits of a bank. It is generally used to ascertain how much money is in a bank in the form of savings account and current account deposits.

A high CASA ratio signifies that most bank deposits are liquid and linked to current and savings deposits. If a bank’s CASA rate is high, it usually shows that the net interest margin is very high, which means that the bank has an excellent operating capacity model. A high CASA ratio is what investors should look for before investing in a banking stock.

Net Interest Margin for accessing a banking stock

The Net Interest Margin (NIM) is the differentiated value between total expenses and the net interest income. It is usually defined as a percentage of average fixed-income assets. The net interest margin measures the profitability of a bank’s investments. It considers the interest a bank makes on its securities and loans, subtracts the interest payable on debt and deposits, and divides it across the value of those securities and loans. For investors looking to invest in banking stocks, a higher net interest rate is desirable.

Non-performing Assets

Non-performing assets (NPAs) determine the risk of loans repayment by debtors to a bank. If no interest or instalment of the principal amount is paid for 90 days, the loan becomes a non-performing asset. NPAs are divided into gross and net non-performing assets. Gross NPA covers the principal and interest on total debt, and net NPA is calculated primarily by deducting bank provisions from all bad loans under Gross NPA.

Credit problems and non-performing assets have threatened Indian state-owned banks in recent years. The State Bank of India, India’s largest public sector bank, recorded 11% of its debt as outstanding loans as NPA in 2018. Investors should consider a bank with low or no NPAs before investing in its stock.

Cost of Liabilities and banking stock relation

Banks carry out different types of activities. But they majorly make money from loaning money to debtors. Simultaneous to banks’ lending activities, the interest payments on the deposits form a significant part of their operating expenses. Thus, deposits are a bank’s liabilities as there is an interest cost they must pay on these deposits.

The banks also need funds to function correctly. For that, it must borrow other than the received deposits. These borrowings usually come from the Reserve Bank of India, other institutions, banks, bonds, etc. Any borrowings carry an interest component that needs to be paid at regular intervals without fail. This interest component that a bank needs to pay is a part of the Cost of Liabilities.

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Cost of liabilities helps an investor get an idea of how much the borrowings cost to the banks. It reflects the cumulative rate a bank pays on its debt.

The lower the cost on the liabilities, the better it is for the banks as it will increase the margins and hence increase the profitability. A high liability price is generally considered bad for a company as it will reduce the margins and increase the company’s interest-paying obligation.

Capital Adequacy Ratio (CAR)

The capital adequacy ratio (CAR) calculates a bank’s available capital divided by the loans sanctioned by the bank. CAR helps estimate the financial strength or capability of the financial institution to meet its responsibilities by using its assets and resources.

A higher the CAR is indicative of a better capitalised bank. In India, as per the RBI norms, Indian-scheduled commercial banks are expected to maintain a CAR of 9 per cent, while Indian public-sector banks are stressed to keep a CAR of 12 per cent.

A bank with a CAR is above the minimum qualifications needed to suggest stability. Therefore, the higher a bank’s CAR, the more likely it is to endure a financial downturn, and thus, it is a good banking stock to buy-in.

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What Is A Taper Tantrum In The Stock Market?

Aakash Sharma — Sat, 09 Oct 2021 05:30:08 +0000

When the economy is under pressure, it is indicative of a liquidity crisis. In such situations, governments and the central banks use the most viable option to avert an economic crisis- buying pre-ordered government bonds and other assets to fill the economy with liquidity. This process is called quantitative easing (QE), and quantitative easing plays a vital role in the topic at hand here, i.e., Taper Tantrum in the stock market.

Recently, with the spread of the COVID-19 pandemic, economic hardship and destruction ensued in every economy worldwide. To tackle the monetary crisis, most central banks, including the Reserve Bank of India, took steps involving quantitative easing to revive the economy by lowering interest rates and sending monetary benefits to citizens.

In this light, the concept of tapering is linked to a central bank’s banking strategy involving the gradual completion of the quantitative easing process.

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Tapering happens when the government stops injecting money into the economy and the banks by reducing its bond purchase to make the economy independent of the extra support gradually.

Quantitative Easing (QE) effect and interest rates

Quantitative easing lowers interest rates. This reduces the returns (ROI) for investors on safe investments, such as certificates of deposit (CDs), money market loans, corporate bonds, etc. Therefore, investors are forced to invest with reasonable risk to generate significant returns. As an alternative, many of these investors consider building their stock market investment portfolios which heavily alter stock prices and increase volatility.

Falling interest rates also influence the decisions of listed companies. Lower interest rates mean lower borrowing costs. This encourages companies to grow their business and borrow more often.

Taper Tantrum

Tapering is the decrease of the rate at which a central bank purchases new assets. It is a gradual reduction in the flow of significant acquisitions of goods and securities by a central bank. Once the tapering is complete, a central bank may reduce the balance sheet size. The goal is to remove financial rewards and incentives slowly.

Tapering is not a new phenomenon. However, the first time it occurred in a way that had a significant global impact was during the 2013 Taper Tantrum. The “tantrum” resulted from the overestimated fears of stock market participants after the US government announced aid cuts.

The 2013 Taper Tantrum

The 2008 financial crunch led to a prolonged recession. As a result, the stock market experienced an unprecedented atmosphere of panic selling shares and other securities. Using the quantitative easing strategy, the US federal government immediately took steps to purchase large government bonds to maintain some form of liquidity in the economy.

This assisted in keeping the lending charges low and increased liquidity in the economy, assuring the investors of a better future.

Low-interest rates encouraged many people to increase credit and spending and accelerated the growth of businesses. From 2008 to 2015, the US government’s investment in the economy was approximately $4.5 trillion, up from $870 billion until 2007.

It’s important to remember that government-led investing in the economy is a short-term solution to a financial crunch. A long-term liquidity infusion by the government can lead to a high inflation rate in an economy.

When the US economy started to improve, the federal government announced a plan to lower the quantitative easing program by 2013. The US market weakened and fell by 4%, fuelling an international stock market downturn. The ‘digitally super-charged’ investors blew it up worldwide, and international markets reacted negatively to an event they should have already been expecting.

Indian stock market

Due to low interest rates on loans during the QE phase in the US, borrowers were in an accessible position when the lending position was stressed. Even though there was more money to be borrowed, lower interest rates hurt lenders. The financial sector needed more consistency. Around this time, American investors began parking funds in Asian markets, including the emerging Indian market—this boosted foreign investment and FDI in India.

As the US government implemented tapering, US interest rates rose, and investors started returning home to get better returns on their investments. In doing so, they pulled out funds from the Indian ecosystem.

Following this rebound, the Indian Rupee fell significantly along with foreign investment returns. This pushed the Reserve Bank of India to raise interest rates overnight. The dollar continued to strengthen, leading to inflation in India. This put investors in a frenzy of crisis and disrupted the growing economy.

India and other emerging markets were hit hard by inflationary pressures. The pain increased as the currency depreciated against the US dollar. After tapering, investors expected a catastrophe on the stock markets. But the impact was cushioned and thankfully short-lived.

Impact of tapering on markets

As mentioned above, tapering often leads to ‘taper tantrums’, i.e., the common panic that accompanies the central bank decreasing its QE program. As central banks start to buy fewer assets, fears that liquidity would decline, and the global market could crumble generates fear waves among investors.

A taper tantrum often pans across bond prices. And when bond prices decline, bond yields grow. There is always a probability that shares and indices could accompany the trend since the bond market boosts stocks. However, in previous tapering scenarios, this has never actually occurred.

During the US tapering, interest rates and bond yields rose. The US stock market performed fine, while the impact on Indian markets was minor. Between 2013 and January 2020, before the onset of the COVID-19 pandemic, Sensex rose by a massive 105%.

COVID induced impacts on stock markets and investors

Due to the COVID-19 pandemic and its associated risks, the US Federal Government began acquiring government assets and bonds again in 2020. The Federal Government bought securities worth $120 billion from the market. But as the situation improves, tapering by slashing the bond-buying programme is inevitable.

Since investment into India ever since the US restarted its bond-buying programme has not been notable, India may not have much to lose if a situation of investor outgo arises. Despite the announcement, the Indian markets cushioned volatility and fell by 1%, keeping its record-high performance.

As the news of a fresh round of tapering is breaking, many are curious about its impact on the Indian market. It is given even more importance due to the possibility of a third COVID wave.

The fact for the Indian market and economic conditions remains that the economy’s fundamentals are much better than what they were during the global fiscal crisis. So, experts anticipate that while there may be some short-term impact, the tapering process will not affect the Indian economy that much.

The impact on Indian equities may be negligent, as seen during the first taper. Internal institutional investors such as mutual, insurance and pension funds can step up the buying to reduce the impact. With the retail investors’ population increasing in India, prominent foreign portfolio investor (FPI) outflows may not adversely affect the market much.

Nonetheless, the stock market is unpredictable, and it is reasonable that investors remain careful of their positions on the stock market.

The post What Is A Taper Tantrum In The Stock Market? appeared first on Dutch Uncles.

Independent India’s Business History

Aakash Sharma — Sun, 15 Aug 2021 05:35:08 +0000

From the reassuring certainty of the five-year plans and liberalisation to the sweeping economic policies such as Make in India, Goods and Service Tax, Digital India and much more, the 75 years of independent India’s history have been marked by events that reveal a young nation in search of an effective development model.

As we celebrate Indian Independence from British colonial rule, let us delve into the history of Independent India’s business ecosystem and financial world and see which events shaped the course of our nation’s economy.

Highlights of business since Independence till date

Starting from 1947, the Central Legislative Assembly, a precursor to the contemporary Indian Parliament, enacted the Industrial Disputes Act to govern organised industrial labour. In 1949, the Reserve Bank of India – RBI- previously a shareholders’ bank, was nationalised and was made the central bank.

The year 1950 marked a genuinely Indian legislative era in which the Parliament made the laws. In 1950, the Planning Commission was constituted as a central planning body, and in 1951, the government presented the First Five-Year Plan. In this decade itself, in 1956, the Industrial Policy Resolution was passed by the Indian Parliament, marking the beginning of the Licence Raj.

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The First Five-Year Plan was based on the Harrod-Domar economic growth model and focused on the primary sector activities like agriculture, mining, fishing, forestry, dairy, etc., dependent on using natural resources.

The 1960s were the real test for the young nation of India. After independence, wars, poverty, illiteracy, and other serious problems were ailing the country. In 1965, the Green Revolution was initiated to combat India’s food crisis, and farmers were given high yielding seeds to produce wheat and essential crops for the masses. Further, in 1968, the Foreign Investment Board was established.

Fast forward two decades, in 1985, Prime Minister Rajiv Gandhi kicked off significant tax reforms with V.P. Singh as finance minister. In 1986, S&P BSE Sensex, India’s first equity index, was launched. And the following year, India’s first debit card was introduced by Citi Bank, the first ATM installed in Mumbai by HSBC.

Before and after liberalisation

The 1990s were a critical time for the Indian economy and the nation as a whole. As the closed economy showed signs of decadence, brokers and License Raj monopolies plagued the system. In 1991, the balance of payments crisis hit India. The critical situation meant that the Indian foreign exchange reserves could have marginally afforded three weeks’ worth of imports.

The pressure, in turn, paved the path for the liberalisation of the Indian economy. Thus, in 1991, Prime Minister P.V. Narasimha Rao and then Finance Minister Dr Manmohan Singh-led budget ushered in the era of liberalisation. This structural reform opened the Indian economy to participation from foreign entities in its industries, including state-owned enterprises.

In the new millennium, India also participated in the global tech boom. Many Indian companies like Infosys, Tech Mahindra, Wipro, among others, reaped the benefits of the tech boom. And start-ups like Shaadi.com, Make My Trip and others were born from the ‘dot.com‘ era.

In recent years, economic policies by PM Modi and his government are being made with the focus on making India a manufacturing hub of the world and campaigns like Make in India, Digital India, Start-up India, etc., are the key contributors towards that goal.

Start-up and India before Independence and now

India has always been an entrepreneurial country. Barely 300 years ago, India had a 25 per cent share of the global GDP. Colonisation kept the country away from the Industrial Revolution, reducing that share to 2 percent of global GDP in 1947.

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The Swadeshi Movement and the revival of domestic products and production processes helped restore the indigenous Indian Start-up ecosystem.

Modern entrepreneurs are trying to understand today’s youth’s everyday problems and solve them in the best possible way. Massive funding, consolidation activities, and a growing domestic market have altered the start-up culture in the last decade.

SMEs and India

The Small and Medium Enterprises (SMEs) segment has emerged as a crucial sector of the Indian economy, contributing significantly to exports, innovation, employment generation, and inclusive growth. SMEs are the backbone of the socio-economic development of India.

The joy of being an independent country and the benefits of being a republic

Freedom does incredible wonders, and it is rightly applicable to the Indian small business and start-up ecosystem. The economic liberalisation, technological advances, more accessible resources, knowledge pool, massive funding, emerging global standards, thriving domestic markets, and reduced communication gap over the years have boosted the Indian economy on the shoulders of small businesses.

This has been possible because of the liberty of decision making that let the Indian governments and stakeholders keep the Indian interest at the centre. Independence and freedom have allowed India to undergo a metamorphosis to re-make a nation after hundreds of years of oppression.

India’s start-up and small business bringing the Indian economy to the world map

The conducive economic environment that took decades to make has promoted entrepreneurs to take up new ventures and turn them into reality. Start-ups are heading the country’s economic growth even when the overall situation seems grim, and the pandemic is making matters worse.

SMEs and start-ups are employing youth and talent that otherwise goes wasted in an economic downturn like India currently faces. Indeed, the employment opportunities and emphasis on regional development encouraged by entrepreneurship have put the Indian economy on the world map – it has been possible due to small businesses and start-up’s initiations.

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