Over the last few years Indian Banking, in its attempt to integrate itself with the global banking has been facing lots of hurdles in its way due to its inherent weaknesses, despite its high sounding claims and lofty achievements. In a developing country like ours, banking is seen as an important instrument of development, while with the strenuous NPAs, banks have become helpless burden on the economy. Looking to the changing scenario at the world level, the problem becomes more ironical because Indian banking, cannot afford to remain unresponsive to the global requirements. The banks are, however, aware of the grim situation and are trying their level best to reduce the NPAs ever since the regulatory authorities i.e., Reserve Bank of India and the Government of India are seriously chasing up the issue. Banks are exposed to credit risk, liquidity risk, interest risk, market risk, operational risk and management/ownership risk. It is the credit risk which stands out as the most dreaded one. Though often associated with lending, credit risk arises whenever a party enters into an obligation to make payment or deliver value to the bank. The nature and extent of credit risk, therefore, depend on the quality of loan assets and soundness of investments. Based on the income, expenditure, net interest income, NPAs and capital adequacy one can comment on the profitability and the long run sustenance of the bank. Further, a comparative study on the performance of various banks can be done using a ratio analysis of these parameters. There are a number of ratios that can be used to comment on the different aspects :
The essential ratios that can be used for assessing the banks’ profitability and sustenance are
Profitability
Intermediation Costs/Total Assets
Assets
Net Interest Income/Total Assets
Other Income/Total Assets
Asset Quality
NPAs/Total Assets
NPAs/Advances
Staff Productivity
Net Profit/ Total Number of Employee
Sustenance
Capital/RWAs
For commenting on the Bank’s performance, a comparison to the total assets of the bank will give a true picture.
Controlled Expenses
The intermediation costs of a bank refer to the operating cost of the bank and include all the administration and operational costs incurred while offering its services. The ratio of the intermediation costs of the bank to the total assets should be kept low to ensure greater profitability. As mentioned earlier, a technology savvy bank will always be in a better position to reduce its operating costs. Consider the operating expenses of the various banking sectors and the industry average for the year 1999-2000. The costs for the entire SCBs rose by 9.1 percent. The maximum rise of 25.1 percent has been witnessed in the new private sector banks while the foreign banks experienced a decline in the operating costs by 3.3 percent. The ratio of the intermediation costs to the total assets indicates a decline. The maximum decline was in the case of new private sector banks and the foreign banks.
Margins – Lowered by Subdued Interest Rates
The ratio of the net interest income (Spread) to the total assets gives the net interest margin of the bank. This ratio is the actual measure of the bank’s performance as an intermediary, as it examines the bank’s ability in mobilizing lower cost funds and investing them at a reasonably higher interest. By borrowing short and lending long, banks can earn higher spreads nevertheless by doing so they will be exposed to greater risks. Hence banks need to be cautious and should not accept risks beyond their ability to control/manage them. Product innovation using the right technology is one approach, which can be followed by the banks to mobilize cheaper funds.
Asset Quality – NPA burden lowering
The asset quality of the banks can be examined by considering the NPAs. These NPAs should be considered against not just total assets but also against the advances, cause the NPAs primarily arise. When NPAs arise, banks have to make provision for the same as per the regulatory prescriptions. When the provisions are adjusted against the Gross NPAs it gives rise to the net NPAs. Provisions reduce the risk exposure arising due to the NPAs to a reasonable extent as they ensure that the banks sustain the possible loss arising from these assets.
Capital Adequacy Ratio-Strengthening Further
The one important parameter that essentially relates to the bank’s ability to sustain the losses due to risk exposures is the bank’s capital. The intermediation activity exposes the bank to a variety of risks. Cases of big banks collapsing due to their bank’s inability to sustain the risk exposures is readily available. Considering this, it is highly essential to examine the capital vis-à-vis the risk weighted assets. This is the Capital to Risk Weighted Assets Ratio (CRAR) as given by the Basle Committee. The statutory prescription for CRAR is 9 percent, which has been well surpassed by most banks.
LIST of Ratios for Analysis of Performance of Banks
Profitability Ratios Interest Expenses/Total Income Non-Interest Expenses/Total Income Non-Interest Income/ Non-Interest Expenses Interest Income/ Total Assets Interest Expenses/ Total Assets Net Interest Margin (NIM) = NII/ Total Assets Profit Margin = Net Profit/ Total Income Asset Utilization = Total Income/Total Assets Equity Multiplier = Total Assets/ Equity Return on Assets = Net Profit/ Total Assets Return on Equity = Net Profit/ Equity
Sustenance:
Capital to Risk Weighted Assets (CRAR) = Total Capital/ (RWAs) Core CRAR = Tier I Capital / RWAs Adjusted CRAR = (Total Capital – Net NPAs)/(RWAs – Net NPAs)
Staff Productivity
Net Total Income/ Number of Employees Profit per Employee = Net Profit/Number of Employees Business per Employee = (Advances + Deposits)/Number of Employees Break-even Volume of Incremental Cost per Employee = Cost per Employee/ NIM Asset Quality Gross NPAs/ Gross Advances Gross NPAs/Total Assets Net NPAs/ Net Advances Net NPAs/ Total Assets Provisions for loan losses/Gross Advances Incremental RWAs/ Incremental Total Assets Total Assets Provisions for loans and investments/Total Assets
(RWA = Risk Weighted Assets)
concepts used in the ratios are as follows:
Cash in cash-deposit ratio includes cash in hand and balances with RBI.
2. Investments in investment-deposit ratio represent total investments including investments in non-SLR Securities.
3. Net interest margin is defined as the total interest earned less total interest paid.
4. Intermediation cost is defined as total operating expenses.
5. Wage bills is defined as payments to and provisions for employees (PPE).
6. Operating profit is defined as total earnings less total expenses, excluding provisions and Contingencies.
7. Burden is defined as the total non-interest expenses less total non-interest income.
Definitions of the ratios are as follows:
1. Cash-Deposit ratio = (Cash in hand + Balances with RBI) / Deposits
2. Ratio of secured advances to total advances = (Advances secured by tangible assets + Advances Covered by bank or Govt. guarantees) / Advances
3. Ratio of interest income to total assets = Interest earned / Total assets
4. Ratio of net interest margin to total assets = (Interest earned – Interest paid) / Total assets
5. Ratio of non-interest income to total assets = other income / Total assets
6. Ratio of intermediation cost to total assets = Operating expenses / Total assets
7. Ratio of wage bill to intermediation costs (Operating Expenses) = PPE / Operating Expenses
8. Ratio of wage bill to total expenses = PPE / Total expenses
9. Ratio of wage bill to total income = PPE / Total income
10. Ratio of burden to total assets = (Operating expenses – Other income) / Total assets.
11. Ratio of burden to interest income = (Operating expenses – Other income) / Interest income
12. Ratio of operating profits to total assets = Operating profit / Total assets
13. Return on assets = Net Profit / Total Assets
14. Return on Equity = Net Profit / (Capital + Reserves and Surplus)
15. Cost of Deposits = IPD / Deposits
16. Cost of Borrowings = IPB / Borrowings
17. Cost of Funds = (IPD + IPB) / (Deposits + Borrowings)
18. Return on Advances = IEA / Advances
19. Return on Investments = IEI / Investments
20. Return on Advances adjusted to Cost of Funds = Return on Advances – Cost of Funds
21. Return on Investment adjusted to Cost of Funds = Return on Investments – Cost of Funds
On the basis of these parameters try to compile a comparative assessment as under:
All Commercial Banks (or the Banking system) Public Sector Banks Old Private Sector Banks New Private Sector Banks Foreign Banks
This will indicate the comparative performance of your bank in relation to each group and the banking system as a whole. But if one prepare the comparative statistics for the bank for the last three years, it will also indicate the direction in which the bank is progressing.