Local banking shares undervalued compared to frontier markets
With the recovery in economic activity supported by monetary easing and fiscal stimulus, an upward trend in the banking sector lending is likely, analysts say.
Recently introduced regulation on capital adequacy is expected to provide more leeway for the mid to large banking segment, supporting credit expansion, they say noting that the sector has a heavy focus on cost management via digitisation and automation which is expected to reduce cost to income ratio and enable to improve bank bottom lines. “We expect capital rich banks to capture market share with the support of new digital platforms and automation measures while the overall credit is expected to grow at a moderate pace of 14 per cent. The overall earnings of the banking sector will grow at a CAGR of 19 per cent in 2019E- 21E,” Srirangan Atchuthan, Assistant Manager Research (Fixed Income and Equity, First Capital
Holdings said at the First Capital ‘ Investment Strategy 2020 – 2nd Research Conference’ on Tuesday at the Cinnamon Grand.
“The profitability of banks was ne g at ive l y i mpacted by t he introduction of Debt Repayment Levy (DRL) since October 2018, adding on to the existing taxes, VAT of 15 per cent and NBT of 2 per cent. Also the adoption o f SLFRS 9 and implementation of Basel III were expected to improve the asset quality of the banking sector in the long term, it continued to be challenging for banks during this period with rising nonperforming loans further hampering profitability and reserves," he said.
The combined effect of the abovementioned factors led to a decline in ROEs of banks in the backdrop of the new capital raised to meet regulatory requirements creating a base effect.
The banking industry will remain slightly challenging in the short to midterm due to the transition to higher capital standards under Basel III and adoption of SLFRS 9, although in the long run implementation of Basel III and SLFRS 9 will improve the resilience and stability of the banking sector, Mr. Atchuthan added.
The growth in the economy during the first six months of 2019 was hampered due to a combination of events; the spillover effects of the political turmoil experienced during the latter part of 2018 and the Easter Sunday attacks in April 2019. This put the growth trajectory of the economy on a slowdown as GDP growth reached a mere 2.6 per cent in 1H2019 compared to 4 per cent in the corresponding period in 2018. All subsectors of the economy witnessed a significant slowdown in 2Q2019 compared to 1Q2019 as the events of April 2019 took a severe toll on economic activity of the country. The banking sector felt the economic slowdown, as private sector credit growth declined, and credit contraction was observed in some months over the period. This led to an industry- wide slowdown in growth of loans and advances, Mr. Atchuthan added.
In order to circumvent these adverse developments, the Central Bank took prudent actions and followed an accommodative monetary policy stance during the period. The policy rates were reduced in two separate instances up to August 2019 with the intention of resolving liquidity shortages and boosting credit growth. The Central Bank imposed an interest rate limit on all deposits in April 2019 when intended results of policy reductions did not materialise. As interest rates still failed to come down to the required levels, the regulator took further measures by imposing a 200 basis point cut on lending rates in October 2019, while removing the previously imposed deposit cap.