Sunday, October 29, 2006

Sector Analysis: Banking

We have seen the financial results for the IInd Qtr. ending Sept. 06 of the premier banks in the country viz, ICICI Bank and SBI recently.

So what are the important result areas where we should compare them? To my mind, the following factors have immense bearing on performance evaluation of a Bank:

  1. Net interest margin (NIM): For banks, interest expenses are their main costs (similar to manufacturing cost for companies) and interest income is their main revenue source. The difference between interest income and expense is known as net interest income. It is the income, which the bank earns from its core business of lending. Net interest margin is the net interest income earned by the bank on its average earning assets. These assets comprises of advances, investments, balance with the RBI and money at call.
  2. Operating profit margins (OPM): Banks operating profit is calculated after deducting administrative expenses, which mainly include salary cost and network expansion cost. Operating margins are profits earned by the bank on its total interest income. For some private sector banks the ratio is negative on account of their large IT and network expansion spending.
  3. Cost to income ratio: Controlling overheads are critical for enhancing the bank's return on equity. Branch rationalization and technology upgradation account for a major part of operating expenses for new generation banks. Even though, these expenses result in higher cost to income ratio, in long term they help the bank in improving its return on equity. The ratio is calculated as a proportion of operating profit including non-interest income (fee based income).
  4. Credit to deposit ratio (CD ratio): The ratio is indicative of the percentage of funds lent by the bank out of the total amount raised through deposits. Higher ratio reflects ability of the bank to make optimal use of the available resources. The point to note here is that loans given by bank would also include its investments in debentures, bonds and commercial papers of the companies (these are generally included as part of investments in the balance sheet).
  5. Capital adequacy ratio (CAR): A bank's capital ratio is the ratio of qualifying capital to risk adjusted (or weighted) assets. The RBI has set the minimum capital adequacy ratio at 10% as on March 2002 for all banks. A ratio below the minimum indicates that the bank is not adequately capitalized to expand its operations. The ratio ensures that the bank do not expand their business without having adequate capital.
  6. NPA ratio: The net non-performing assets to loans (advances) ratio is used as a measure of the overall quality of the bank's loan book. Net NPAs are calculated by reducing cumulative balance of provisions outstanding at a period end from gross NPAs. Higher ratio reflects rising bad quality of loans.

This list is not at all exhaustive. There are a number of other indicators like efficiency and profitability ratios. For newbies like me, it's more than enough numbers!!!

And btw, the NIM of SBI is higher compared to ICICI and HDFC by 1% (approx.)!!!

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