Latha Venkatesh | Chief Economist of Axis Bank and Neelkanth Mishra, Head of Global Research at Axis Capital, have advised investors to invest in banking stocks. He has cited improved liquidity conditions and increased credit growth for investing in banking stocks.

"The challenge in the last 2 years has been that in terms of volumes, I mean the raw material (deposits or cash reserves) that banks work with, was starting to become a problem," Mishra said. He referred to liquidity conditions affecting banks' lending capacity. Slowdown in growth The Reserve Bank of India's (RBI) tight stance on liquidity and high loan-deposit ratio had slowed loan and deposit growth. This had created a "downward spiral" in the banking sector. "If banks start cutting loans or slowing loan growth, it will also slow down deposit growth, and then the whole thing starts going down," he said. However, the RBI has recently softened its stance on liquidity. The RBI believes that doing so will encourage banks to lend more freely. As banks adopt the "neutral" stance announced by the RBI in October, loan growth will pick up and pressure on wholesale deposit rates will gradually ease, allowing banks to improve margins and expand lending. "When the banking system understands that the RBI's liquidity stance has changed, and changed forever... then the credit impulse starts to improve," Mishra added. However, he does not expect a rate cut "until April at the earliest." Mishra sees the easing of liquidity constraints as a key factor in preparing banks for growth.