Banks were considered to be the safest financial institutions in India. However, in recent years, there have been instances of scams and large-scale banking failures, creating doubts in our minds regarding the safety of our funds.
This may reflect on the banks’ stock market performance as well.
In this article, we will talk about the financial aspects that make a bank strong and how you can check the financial health of any bank using simple ratios.
Non-Performing Assets (GNPA & NNPA)
1. Definition of NPA
For a bank, an asset is anything that offers income. Therefore, the loans offered by banks are their assets. The interest paid by borrowers is the primary source of income for most banks. As long as the borrower pays the instalments, the asset is said to be performing. However, if the borrower starts defaulting and reaches a stage where repayment of the loan is not possible, then the asset is said to be non-performing.
“An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank. A ‘non-performing asset’ (NPA) was defined as a credit facility in respect of which the interest and/ or installment of principal has remained ‘past due’ for a specified period of time.”
DBOD No. BP.BC/ 20 /21.04.048 /2001-2002 (RBI)
2. Understanding NPA Provisioning
When a bank issues loans, it knows that some borrowers might default and not be able to repay the amount. To ensure that such defaults don’t derail the bank’s finances, it sets aside an amount every year for non-performing assets or NPAs. This amount is called ‘provisions’. Baks usually set aside provisions from their net profit.
Every bank has different NPA provisioning since it depends on a lot of factors.
3. GNPA – Gross Non-Performing Assets
Gross NPA is the total value of non-performing assets of the bank. This is an absolute number and can tell you the amount of loans that the bank is not earning money on.
GNPA can also be expressed as a percentage of the total loans issued by the bank. This can tell you the percentage of the total loans that are currently non-recoverable.
Example: If a bank has issued a total of Rs.100 crore as loans and has a GNPA of Rs.5 crore, then the GNPA percentage will be 5%. In other words, five percent of the loans issued by the bank are currently non-recoverable.
Remember, a high GNPA means the bank has a poor quality of assets.
4. NNPA – Net Non-Performing Assets
As explained above, banks set aside funds for uncertain loans issued by them. Therefore, the net impact of the non-performing assets can be understood by subtracting the NPA Provisioning amount from GNPA. This is the Net NPA.
NNPA = GNPA – NPA Provisioning
Example: Like GNPA, NNPA can also be expressed as a percentage. If a bank has issued a total of Rs.100 crore as loans, a GNPA of Rs.5 crore, and NPA Provisioning of Rs.2 crore, then the NNPA will be Rs.3 crore and the NNPA percentage will be 3%.
Provisioning Coverage Ratio (PCR)
A Provisioning Coverage Ratio or PCR is the percentage of funds that a bank sets aside for losses due to bad debts. A high PCR can be beneficial to banks to buffer themselves against losses if the NPAs start increasing faster.
A quick glance at the PCR ratio of the bank can tell you if the bank is vulnerable to NPAs or not. Typically, a PCR ratio of 70%+ is considered healthy for banks.
Provision Coverage Ratio = Total provisions / Gross NPAs.
Capital Adequacy Ratio (CAR)
One of the best ways to assess a bank’s potential to absorb losses is to look at its Capital Adequacy Ratio or CAR. In simple terms, this ratio measures how muh capital does a bank have in comparison to its credit exposure. The CAR is enforced by banking regulators to ensure that banks don’t take excess leverage and turn insolvent.
A high CAR indicates that the bank has enough capital to manage sudden losses. On the other hand, a low CAR indicates a bank that carries the risk of failure. RBI announces the CAR required for banks in accordance with Basel norms time to time. A CAR of 8-12% is usually considered average.
Current Account Savings Account (CASA) Ratio
A bank offers current accounts and savings accounts to people. These are low-cost deposits since the bank pays a low-interest rate on them and utilizes the funds to offer loans to borrowers. The Current Account Savings Account or CASA Ratio is the ratio of the deposits across current and savings accounts to the total deposits of the bank.
A high CASA ratio would mean that the bank has enough funds at a lower cost offering an opportunity to earn good profits. If the CASA ratio is low, then the bank might have to rely on costlier sources of funds. You can look at the CASA ratios of a few banks to get an estimate of an average value and assess the financial health of the bank you are analyzing accordingly.
Net Interest Margin (NIM)
A bank accepts deposits from customers at a lower rate and offers loans to borrowers at a higher rate. Ideally, all banks should be profitable. However, profitability depends on two factors – the cost of funds and the lending rates. Banks with low CASA ratios have a higher cost of funds. Hence, to be profitable they will have to offer loans at a higher rate. To understand the profitability and efficiency of a bank’s investment decisions, you can use the Net Interest Margin or NIM Ratio.
The NIM ratio is calculated as follows:
NIM=(Income from investments-Interest Expenses)Average Earning Assets
In simpler terms, NIM offers a quick insight into the difference between the interest earned by a bank on loans as opposed to the interest paid on deposits.
Banks with high NIM ratios tend to have low-0cost deposits and/or high lending rates.
Price to Book (P/B) Ratio
Before we look at the P/B Ratio, let’s understand some basics.
- Book Value = Total Assets – Total Liabilities
- Market Capitalization = Market value of the bank’s stock x Total outstanding shares
PB Ratio = Market Capitalization / Book Value
This is an excellent way of understanding the relationship between the market’s perception of the bank’s stocks and its book value.
- Gross Non-Performing Assets (GNPA) offer insights into the total value of non-performing assets of the bank.
- Net Non-Performing Assets (NNPA) is the portion of the bad loans of the bank that has not been provisioned for.
- Provisioning Coverage Ratio (PCR) is the percentage of funds that a bank sets aside for covering losses due to bad debts.
- Capital Adequacy Ratio or CAR is the ratio of the bank’s capital to its credit exposure.
- Current Account Savings Account or CASA Ratio is the ratio of the deposits across current and savings accounts to the total deposits of the bank.
- Net Interest Margin or NIM Ratio is the difference between the interest earned by a bank on loans as opposed to the interest paid on deposits.
- Price to Book or P/B Ratio describes the relationship between the market’s perception of the bank’s stocks and its book value.
Q1. Is my bank safe?
To ascertain the financial health of a bank, you can check the following ratios:
Q2. Where can I find these ratios?
Most of these ratios can be found in the Annual Report or Auditor’s Report of the company. Some are also available in the quarterly results report.