How investing in bank stocks different from the rest?

The business of banking falls under priority services and all banks whether public or private in India need to comply with stringent guidelines by the RBI. While NPAs (nonperforming assets) are part of their businesses, there is a limit set by RBI as part of good governance. New banks are allowed to float only after they demonstrate they are here for a long run.

While steel plants and the business of jewelry should also be relevant for years and decades to come, there is a difference: banks finance all kinds of businesses from small retailers to large corporates and government projects. In other words by investing in bank stocks, one gets an exposure to growth of economy as a whole. It is said that banking closely mirrors the economy.

There are many businesses (like a firm producing accounting software) which did not exist a few decades back and one cannot be sure what lies ahead in few years time with rapidly changing distribution channel/consumer taste/change in technology. For such stocks, it is difficult to spot right time to exit and passive shareholders who are taught to invest for long term often lose a significant part of the portfolio.

Government-owned banks (PSUs) are also a vehicle that keeps the government running by generating income through dividends. Most of these banks in good times declare rich dividends ensuring that you also earn decent yearly income in case you stay invested. There are also a couple of more advantages in dividend play including dividend income not taxable (like in India) and dividend stripping.

You can of course spread risk by investing in a number of public and private sector banks as under exceptional circumstance a bank too can go bust as evident in the Global Trust Bank fiasco (2004). This also helps optimize returns from dividends, and a way to optimize the same can be through investing in mutual funds focused on bank stocks like Reliance Banking FundReligare Banking Fund, and UTI Banking. These mutual funds, in addition to bank stocks, may also invest in companies engaged in financial service activities (UTI Banking Sector Fund) or  companies engaged in allied activities related to the banking sector (Reliance Banking Fund). 

Of late, there is a flux of new so-called payment banks that leverage online payment gateway technologies pioneered by the likes of Paytm, and it would be interesting to see how they do in the equity market going forward.

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