Thread by @FincademyIn

What are the most important ratios to analyze a bank ?

A Thread 🧵👇

1/ Bank business is completely different from all sectors. For banks, loans given to their customers are assets and their liability is deposits taken from their customers.

2/ CASA Ratio - It means total % of current account and savings account. Always check the growth in CASA ratio and how much interest is given to their customers in savings accounts.

3/ A higher CASA % means that the bank is able to borrow (deposits) at low rates, hence can earn a higher NIM. It is calculated as Current a/c + Savings a/c ÷ Total deposits.

4/ Net Interest Margin - It means the difference between the interest income earned and the interest paid by a bank. The difference between them is called spread. The higher the spread, the better. To better understand, the following is the example.

5/ Suppose, the bank interest rate is 4% p.a for its customers and 12% p.a. Interest for their customers who have taken loan. The difference is 8% and it’s called spread.

6/ To measure the spread, it is calculated as : Net Interest Income (NII) ÷ Average earning assets.

7/ NII is calculated as Interest Received - Interest Paid. The higher the NIMs, the better would be the bank’s profitability and it will have more cushion to absorb losses due to bad loans. The ideal range is more than 3.75%.

8/ Cost-to-Income Ratio: Banks also have some costs. It has to pay for salaries, office utilities, technology-related expenses, and other expenses. To compare the cost-efficiency, we have the Cost-To-Income Ratio.

9/ The formula is Operating costs ÷ Net Interest Income + Other Income. The lower the Cost-to-Income Ratio, the better is the cost efficiency of the bank. The ideal range should be Below 50%.

10/ Suppose the figure is 40%, it means that compared to the bank’s income, its operating cost is 40%.

11/ Gross Non-Performing Assets - GNPA are the loans that have missed their repayment date by more than 90 days.

12/ The lower the figure, the better is the underwriting of the bank. A low figure suggests the bank is doing proper diligence while advancing the loan. The ideal range should be Below 2%.

13/ Net Non-Performing Assets - Net-NPA is the GNPA minus the provisions made by the Bank. Once a loan turns into an NPA, the banks evaluate what amount it would be able to recover from the lender and creates a provision for the loss it would have to bear in case of a default.

14/ It shows the bad loans % which have not been provided for. More provisions created by the bank will lower the NNPA. It is calculated as Net-NPA ÷ total advances (loan given to its customers). The ideal range should be Below 1%.

15/ Provision Coverage Ratio (PCR) - As discussed above, banks set aside an amount for bad loans. It shows what percent of bad loans have been provided for. The higher the ratio, the more money the bank has set aside for the bad loan. The ideal range should be more than 65%.

16/ Slippage Ratio - Slippage refers to the fresh good loans which turned bad. A falling Slippage ratio across time series indicates prudent lending practice on the bank’s part. It is calculated as New NPAs ÷ Beginning Standard Assets

17/ Capital-to-Risk Weighted Adequacy Ratio (CRAR/CAR) - As banking is a highly leveraged business and it manages public deposits, regulators have come up with CRAR banks have to maintain.

18/ It is like a cushion to absorb losses in case of high bad loans. If the ratio falls below the prescribed %, banks would have to raise funds and dilute equity. CRAR is calculated as:

19/ Credit-to-Deposit Ratio: This liquidity measure indicates how much of the deposit money has the bank used to make advances. A low figure would indicate that the bank has relied on its deposits for advancing loans.

20/ A high figure can cause liquidity issues during bad times as loans are given for a longer time frame but deposits can be withdrawn soon, causing a liquidity crunch for the bank. The ideal range should be Below 90%.

21/ Return on Assets - This profitability ratio shows how efficiently the assets have been used to generate returns. High RoA is supported by higher NIMs and good asset quality (lower provisions).

22/ It is calculated as Operating Profit ÷ Total Assets. The ideal range should be above 2.5%.

23/ While understanding the banking business is fairly easy, one can never be sure about what is hidden in the books, hence along with ratios, it is very very important to also understand the management and its past underwriting track record.

24/ As you have understood the important parameters to check while buying any bank stock, so we have also made a thread on How to pick a GOOD BANK. Checkout the following link 👇

https://twitter.com/FinsenseG/status/1263710021248057345?s=20

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BY :- @sneh_kagrana