Growth impulses in the economy following the cumulative impact of interest rate cuts are expected to keep bank stocks buoyant.
A recent research report by a foreign brokerage house states that there is a significant correlation between bank stock prices and interest rate movements.
Growth expectations tend to change alongside interest rate movements. Working on historical numbers, the report concludes there is an valuation upside of 6 per cent to 24 per cent in the intrinsic value of bank stocks.
The impact will be felt on stocks such as HDFC Bank, SBI, ICICI Bank, the report added.
"A drop in interest rates has two direct and opposite implications for the financial sector, since it provides a fillip to consumer lending and the debt servicing ability of industrial borrowers. However, it is likely to result in industrial borrowers exiting the market in the long term. When the trend in interest rates reverses, the risk for the consumer lending portfolio rises," according to ABN Amro in its report on the impact of interest rates on the financial sector.
In case of SBI, any boost to consumer lending is likely to translate into diversification of the portfolio risk and improved financial ratios.
The scrip is the best value play in the sector since it is trading at a significant discount to the other banks in the public sector. Liquidity has dried up in the stock and foreign ownership has almost touched the ceiling.
HDFC remains the best play in the mortgage finance market, with growth opportunities emerging strong.
The mortgage market is expected to sustain its growth rate in excess of 30 per cent in the current fiscal, aided by the favourable climate for housing investment.
The mortgage market will be the key beneficiary of lower interest rates, since it drives the demand for mortgages, the report says.
Low interest rates will support ICICI Bank's liability re-pricing efforts and keep its asset quality stable.
The cost of equity of the bank has also fallen from 13.1 per cent to 12.4 per cent causing its intrinsic value of the stock to rise.
When interest rates are low, consumers have lower monthly commitments and, hence, an improved affordability factor.
"The availability of credit for consumer lending improves when interest rates soften owing to weak demand for industrial credit. Bank's risk appetite also increases in this period," the report stated.
Other consumer lending segments are also likely to get a boost from lower rates. A lower interest rate coupled with banks' expanding reach and higher risk appetite will drive up the penetration of consumer financing in household purchases from 60 per cent in the last fiscal to 75 per cent by fiscal 2007.