Banking equities have been among the hardest affected during the latest selloff in the Indian stock market. However, numerous experts believe the pressure is only transitory, since many banking companies are great investment opportunities in the medium to long term.

So far in May, the Nifty Bank index is down more than 3%, while the stock benchmark Nifty 50 has fallen by 2%. The Nifty PSU Bank index is down 6% this month, while the Nifty Private Bank index has fallen 3%. Despite posting a roughly 160 percent year-on-year increase in Q4FY24 net profit to ₹3,010.27 crore, Punjab National Bank's shares fell 12% this month.

Experts Remain Positive

Most experts are optimistic about banking equities, citing no serious concerns in their fundamentals. The RBI's plan to tighten project financing criteria appears to be the primary driver of the selloff in banking equities.

"The current pressure on banking sector stocks is due to the RBI's intention to tighten project financing regulations by requiring standard asset provisioning of up to 5% on loans. However, we feel the latest reaction is more sentimental, and the sector's overall outlook remains good," said Shreyansh V. Shah, a StoxBox research analyst.

On May 3, the RBI released a draft prudential framework for banks involved in project finance. The framework proposes gradually increasing standard asset provisioning to 1-5 percent of loans from the existing 0.4 percent for project loans that are not overdue or stressed.

Another factor contributing to recent impact on banking stocks is weak market sentiment caused by Lok Sabha election-related worries.

Several big banks' fourth-quarter results were broadly consistent with expectations. Banking stocks are expected to regain emphasis following the election results, according to experts.

"Banking stocks reported in-line results, with decreased provisioning and strong credit growth boosting profitability. Regulatory diktats and institutional over-ownership may impede further large rerating of banking equities in general, with a few exceptions. However, we may see renewed interest in these equities (particularly in PSU banks) following the election, with the anticipation of reforms and divestiture," said Deepak Jasani, Head of Retail Research at HDFC Securities.

"The banking sector's fourth-quarter results were mostly in line with market expectations." The NIMs had a fairly flattish trend with minimal deterioration, while asset quality was constant. While loan growth remained strong, the highlight of this quarter was a sequential increase in deposits as a result of smart deposit mobilisation," stated Shah of Stoxbox.

What to buy?

Shah's top banking picks include SBI, IndusInd Bank, and J&K Bank. Anand Dama, Emkay Global's head of BFSI Research, is optimistic about the banking sector, citing a strong margin and treasury outlook, as well as better headline asset quality. He is more optimistic about public sector banks like Indian Bank, SBI, and Bank of Baroda. Among private banks, he favors ICICI Bank, Axis Bank, and Karur Vysya Bank.

Vijay Singh Gour, a senior analyst at Choice Broking, suggests SBI, IndusInd Bank, ICICI Bank, and Axis Bank as his top options. 

Gour stated that they performed well in Q4FY24 and are anticipated to maintain this performance in FY25 and FY26.

IndusInd Bank is a superior pick among private banks due to its outstanding performance in Q4 FY24. The bank's loan growth is likely to continue in FY25 and FY26. Contributions for higher yield items are projected to increase, keeping margins slightly higher. Gour expects asset quality to increase over the next two years, as well as a good return ratio.

According to Gour. "Among public sector banks, SBI delivered strong results in Q4FY24 and FY24. The bank's loan growth is predicted to be solid, ranging from 13 to 15 percent in FY25 and FY26, while net profit is expected to expand at a CAGR of 14 percent during the same time. The NIM (net interest margin) is predicted to stabilize at its current level, while the RoA (return on assets) will remain over 1% in FY25 and FY26. SBI is projected to benefit from economic growth and lower operating costs as a result of digitalization.”

However, Amit Goel, Co-founder and Chief Global Strategist at Pace 360, is skeptical about banking stocks in the short term due to their high valuations.

"Valuations are overstretched just as an imminent global recession threatens corporate earnings. Even considering the growth trajectory of many stocks, the current valuations don't justify them. Hence, we will continue to be underweight in these stocks," Goel stated.

"Due to stretched valuations, investors should remain cautious and hold off on making investments until a sizable market correction occurs. After a sizable correction, we prefer Canara Bank, SBI, and Axis Bank stocks," Goel stated.