Financial services stocks such as Religare Enterprises (RELG.NS) and M&M Financial Services (MMFS.NS) rose on Monday on hopes the companies would win bank licences, after the RBI unveiled new rules for applicants late on Friday.
While bank hopefuls covet low-cost retail deposits and fee opportunities, some analysts warned it would not be an easy ride for new entrants in the sector due to competition, the high cost of meeting regulatory and technology requirements and stiffer provisioning requirements.
The Reserve Bank of India (RBI) on Friday announced rules that would allow any type of company to apply for a banking licence, paving the way for India's first new banks since the formation of Yes Bank (YESB.NS) in 2004.
While dozens of companies are expected to apply for licences by the July 1 deadline, the Reserve Bank of India is expected to be very selective, with many observers expecting it to cap the number at around five.
"Given the banking penetration is low in India, it's a promising industry for growth but it's also a very challenging business," said J. Venkatesan, a fund manager with Sundaram Mutual Fund.
"They need to do a lot of homework," he said, referring to the potential applicants. "The applicants would be many, but the ultimate winners would be a few."
Shares of the companies that have said they are keen to apply soared, while the broader Mumbai market fell.
Religare rose as much as 12 percent, M&M Financial was up 4.5 percent, L&T Finance (LTFH.NS) rose 5 percent and billionaire Anil Ambani's Reliance Capital (RLCP.NS) gained as much as 3 percent.
"The trade only works from now till the announcement of the bank licences. Once the licences are announced there is no money to be made," said Saurabh Mukherjea, head of equities at Ambit Capital in Mumbai, referring to the surge in the stocks.
Espirito Santo Securities advised investors to "tread with caution" as, the brokerage said, it would take a lot of time before the new banks would be able to leverage the benefits of a banking licence.
With the central bank saying that the new banks would have to start fulfilling so-called priority sector lending requirements from the start, profitability is expected to fall significantly in the initial years of operations, it said.
Typically, priority sector lending includes small loans to farmers for agriculture and related activities, loans to micro and small enterprises, and to low income groups.
There could be a re-rating of potential winners on long-term growth potential in the country's banking sector, but the new players will take at least four to five years to make a real difference in market share, JPMorgan said in a report.
"We still remain quite interested in applying for a banking licence for the kind of bank we want to create, which is to serve the low-income families and small businesses and shopkeepers and truck drivers," said Arun Duggal, chairman of Shriram Capital.
The banking sector could see cut-throat competition as some applicants have deep pockets and the ability to disrupt the landscape, Goldman Sachs said in a report.
In the short-to-medium-term, this may lead to acquisitions of established banks if the RBI permits, which could drive up valuations for existing players, Goldman Sachs wrote.