Outstanding returns expected from Indian Banking & Financial Services Sector

-Dr. Sanjiv Mehta

In a rapidly developing economy, at various stages, certain sectors and themes outperform other components. Indian banking & financial services is one such sector showing a tremendous development potential.

India is one trillion dollar economy with banking and financial services contributing 165 billion dollars, which is only 16.5% of the economy. Taking examples from multiple developed countries, this sector is generally close to 25% of the total economy. While our 5-year view on Indian markets is very bullish as discussed in Sensex, Music & Headphones, this sector should do even better.

One exciting factor leading to higher valuations and consequent returns is a major regulatory change. From 2009 onwards RBI is opening up the sector to foreign players. They will be able to acquire up to 74% of any Indian bank.

Sector has tremendous room for growth. Total market capitalization of the entire Indian banking system is even less than the 20th largest bank in the world. Per capita deposit, loan and insurance premium figures in India are considerably lower than the relative figures of even Korea and Taiwan.

This sector is a direct beneficiary of growing GDP and consequent increase in per capita income. Structural change in savings and investment pattern will unleash various segments of the industry. International banks including Citigroup, HSBC, Bank of America and Deutsche Bank have scaled up their operations in India. Foreign Institutional Investors (FIIs) are also giving importance to this sector. It is expected to grow at 35% annually for the next few years.

Another interesting aspect is that of self-fulfilling prophecy. Infrastructure theme as part of India story caught the fancy of the market from 2004 onwards and there were spate of infrastructure funds introduced one after the other. Their buying drove the valuations up resulting in impressive returns of 40 % compounded annualized for 4 years. Similar thing is happening to Banking Sector now with 5 open ended funds already operating and four waiting for approval. Besides, there are 3 banking ETFs (exchange traded funds). Only condition for a sustainable return is that the popularity of a theme should be based on solid facts and those are very much operative for this sector.

Moreover, the present market correction has made the valuations lower and thus provided attractive buying levels. Indian banks on an average have a Price/Earnings of around 10 and Price/Book hovering near 1.

I am recommending a significant allocation to the Indian Banking and Financial Services sector. Of course three principles of investing in stocks including time horizon, diversification and valuation remain sacrosanct.

Dr Sanjiv Mehta is the MD, Finance Doctor, a wealth management company and author of Winning The Wealth Game: Cricket Strategies For Financial Freedom.