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10 Indian Banking Stocks to Watch

NEW YORK ( Karvy Global) -- HDFC Bank (HDB - Get Report) and ICICI Bank (IBN) are among the Indian bank stocks that have the potential to appreciate despite a recent selloff.

Over the past two weeks, Indian bank stocks plummeted on concerns about the European debt crisis and India's housing loan scandal, in which authorities arrested bank executives in connection with alleged bribery and fraudulent loans.

Adding to the selling were worries about margin pressure because of a rise in deposit rates and slower growth. The declines caused India's BSE banking index to fall 7% in the first two weeks of December.

To be sure, Indian banks will face pressures in an environment of rising interest rates. But the impact will vary depending on the bank. Banks that have a higher percentage of low-cost deposits, such as State Bank of India (SBIN:Mumbai), Punjab National Bank (PNB:Mumbai) and HDFC Bank, will fare better.

So will IDBI Bank (IDBI:Mumbai) and ICICI Bank (IBN), which have hiked lending rates, thereby limiting the negative impact on their margins. We expect margin pressures to become visible over the next two quarters.

In the current fiscal year, Indian banks have managed credit growth of around 10%, which is lower than the Reserve Bank of India's target of 20% for 2010-2011. Nonetheless, we expect robust domestic growth, higher capital expenditures and working capital demand across industries to accelerate credit growth during the next two quarters.

Concerns about the banking sector's exposure to sectors like telecom and real estate surfaced recently. However, the overall exposure to these sectors is around 4% to 5%, and these loans are backed by adequate collateral.

The government is proposing to infuse $2.25 billion into nine banks to shore up their capital bases and fund future growth. The bank that is expected to see the biggest increase in its book value from this infusion is Bank of Baroda (BANKBAROD:Mumbai), followed by Union Bank of India (UNIONBANK:Mumbai).

We have identified large-cap Indian banking stocks that could appreciate. The banks listed here have the advantage of a strong deposit base, better asset liability management, and strong asset quality. They are ranked in ascending order of average upside expected by analysts.

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