Should investors buy bank shares?
The NEPSE is frothy. The banks are not
Image via FT
A bull market tends to flatter the undeserving. As the NEPSE index has rocketed nearly 29% over the last year, share prices have run far ahead of profits. Sectors with scant earnings and loose fundamentals—“Investment”, “Others”, even “Trading”—have outpaced the financial backbone of the economy: the banks. Yet amid the speculative froth, it is the commercial lenders that offer the most sober insight into the economy’s health, and the sharpest tests for investor judgement.
Their assets have swelled to NPR 7.81 trillion, up by nearly 30% over two years. Deposits sit at NPR 6.15 trillion, a healthy bump of 35% since mid-2023. Credit growth, however, has stalled. Loans and advances remain flat at NPR 4.91 trillion. Lending to the government has collapsed, and borrowings from other institutions have fallen, hinting at a sector leaning increasingly on deposits to fund its activities.
Bankers are doing more with less, or at least trying to. Interest income rose 10.5% in the month through mid-May, down to improving yields and some loan growth. Net profit rebounded to NPR 47.8 billion, up nearly 16% from mid-April. But the headline figure flatters to deceive. Profits remain 36% below their 2022 peak, and retained earnings remain stubbornly negative. Capital buffers have risen modestly, but the bulk of improvements are down to reserves rather than fresh equity. After all this is a sector still digesting the excesses of the pre-pandemic credit binge. And those positive signs are less a comeback than a pause for breath.
One clue to the malaise is provisioning. Loan-loss reserves and interest suspense accounts have ballooned, now comprising NPR 672 billion, nearly 9% of total liabilities. Write-offs have grown, and provisioning for risk remains elevated. Meaning banks are still absorbing the delayed fallout of overextended borrowers: especially in sectors like real estate, hydropower and small business credit. That profit is leaping despite those costs says more about clever accounting and write-backs than a genuine earnings recovery.
There are structural reasons for caution. Banks remain over-reliant on fixed deposits, which are expensive and fickle sources of funding. Interest expenses leapt by more than 10% in mid-May alone from a month earlier. Margins are being squeezed. At the same time operating costs continue to spike. Employee and administrative expenses bumped by 11%, indicating inflationary pressures on bank balance sheets that are harder to hedge than those of manufacturing firms.
Yet investors are curiously unenthusiastic. Bank shares, notwithstanding posting a 25% annual gain, have lagged behind the broader NEPSE rally. Their price-to-earnings ratio is 17.2, far below the market average of 48.3. Their dividend yields, at 2.09%, are twice the market-wide average. In valuation terms they are among the few sectors that resemble a market rather than a casino.
There are several ways to interpret this. One is investors expect further deterioration in asset quality and returns on equity. Another is banks, leashed to the central bank’s conservative norms, are viewed as too boring for a market that rewards bravado over balance. A third possibility is the market sees through the sector’s superficial stability. Non-performing assets are likely underreported. The recent doubling of non-banking assets suggests a rise in foreclosed properties and default recoveries, hallmarks of stress more than recovery.
The market’s froth also has behavioural roots. Retail investors dominate the equity market. Many have flocked to sectors with less transparency but higher upside tales: hydropower, speculative trading firms, even life insurance. These segments boast eye-watering valuations—life insurers trade at 73 times earnings—but have yet to justify their price tags with consistent profitability. Meanwhile bank stocks lumber along with the weight of regulatory scrutiny and balance-sheet opacity, among others.
Still, banks may yet prove the tortoise to the market’s hares. As credit demand revives—especially with GDP growth and a bump in private investment—commercial banks will be the primary transmission channel. Unlike most sectors on the NEPSE board, they generate real cashflows. They have brand loyalty and wide distribution as well as regulatory forbearance. If they can stabilise provisioning and trim reliance on expensive deposits, earnings could surprise on the upside.
The contrarian case is compelling: buy bank shares not because they are exciting but precisely because they are not. In an overheated market, they are one of the few sectors grounded in fundamentals. But this is not a wager for adrenaline junkies. It is a patient bet on a sober industry slowly climbing out of a long hangover. The public may have discovered earnings-per-share from a television pitch. But investors looking for real value would do well to revisit the boring old balance sheet. ■