I have written earlier on banks
On valuation approach of banks
More thoughts on valuation of banks
Various factors to evaluate banks
Margin of safety and Banks
I recently posted on a Financial services company ‘sundaram Finance’ which has a business model similar to banks.
I have been analysing banks as a group, trying to understand their business models better. I found the following articles useful to understand the working of a bank
Asset liability management function of banks
Various factors in evaluating banks
NPA and various factors in understanding Bank NPA’s
A few additional thoughts on the business model of banks
- The traditional lending business of banks is now becoming a smaller portion of the business. The ‘other income’ portion which comes from various activities such as distribution of financial products, cash management etc is now becoming more important as this income is not sensitive to interest rate changes and requires less capital
- The % of other income to total profit is higher for the newer private banks than the PSU banks. In addition lower NPA and more profitable growth has resulted in a higher valuation for private banks such as HDFC, ICICI etc
- Banks have been consistently increasing the proportion of their variable rate products. This enables the bank to reduce their Asset liability mismatch.
- Banks profits, especially of PSU banks were subdued last year due to the increase in deposit rates. However PSU bank assets tend to follow the higher rates with a lag. Private banks are able to manage these fluctuations better through various derivative products. I think PSU banks are still lagging in this field. As a result it is likely that several PSU banks will see an expansion of margins as deposit rates stabilize and the Asset yields improve
- NPA’s in most PSU banks though higher than Private banks are still better than a few years ago
I have done a preliminary analysis of the various banks and have found Private sector banks to be fairly or in some cases slightly over-valued. However there are some PSU banks such as Allahabad bank, which I feel are undervalued. I will be posting on Allahabad bank and a few other banks later.