Banking Ratios – How to Assess the Financial Health of Banking Stocks?

7 Banking Ratios to Assess the Financial Health of Stocks: Banks are considered to be one of the safest places to hold your savings. But is this still true today in India? Banks crashing during the 2008 financial crisis and regularly in India thanks to the scams and internal negligence that keeps occurring has raised some serious questions.

In this article, we take a look at some very important ratios that one must look at before investing to check the financial health of banking stocks or simply using its service to hold their funds. Keep reading to find out! 

7 Banking Ratios to Assess the Financial Health of Stocks

Before jumping into the ratios it is very important to understand what a bank considers an asset. In a conventional business, machinery produces products helping them earn an income making it an asset.

For banks, it is loans that the bank gives out which makes it an asset as this helps them earn a profit. (Quick Note: You can find the financial ratios of any banking stocks on Trade Brains Portal.) 

Now let us look at some of the important ratios that may help us assess the health of a bank:

1. Gross Non-Performing Assets (GNPA)

When banks give out loans the probability arises that some clients may default in paying back these loans. The Gross Non-Performing Assets (GNPA) refers to the total value of loans that are not recoverable and also on which the bank will not be earning any money. The GNPA is expressed as a percentage of the total loans issued by a bank.

A high GNPA percentage means that the bank has lent out funds which it will not get back meaning it has a poor quality of assets.

This makes it extremely risky to invest in these banks or use their services to park your savings.

2. Provision Coverage Ratio (PCR) 

After a period of time, the bank realizes that some of the loans which they have already given out may not be received back. Hence banks set aside some amount every year to prepare for this. This amount is known as Non-Performing Asset (NPA) Provisions. 

A provision coverage ratio gives us a picture of up to what extent the bank has tried to protect itself against the loans that are most likely to default. A bank with a high PCR i.e. above 70% shows that it is prepared if these loans default and are healthy. 

3. Net Non-Performing Assets (NNPA)

One of the best indicators of the health of a bank is its NNPA. The Net Non-Performing Assets (NNPA) refer to the loans that the bank expects to go bad but has not created any provisions against it. The NNPA is calculated as follows:

NNPA = GNPA – NPA Provisions

This NNPA is generally expressed as a percentage. The lower the NPA’s the healthier the banks.

 

4. Net Interest Margin (NIM)

Let us first understand the basic working of a bank before we look into how this ratio works. Banks take deposits from the clients in return for interest and to keep their savings safe. But a bank does not keep these funds idle.

They loan out a percentage of their deposits and charge a higher interest rate on these loans. This is how they make profits.

The Net Interest Margin (NIM) refers to the difference between the interest earned by the banks on the loans given out and the interest that they pay out on deposits. 

NIM = Income from Investments (loans) – Interest Paid out on Deposits.

Banks with high NIM are ideal as they have lower costs to earn a profit.  The NIM can also be looked at in combination with NPA’s. A bank having a low NIM and high NPA is a very unhealthy sign. 

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5. Capital Adequacy Ratio (CAR)

The Capital Adequacy Ratio (CAR) is the ratio of the bank’s capital to its credit exposure. This ratio measures the banks’ ability to meet their obligations in the future without having to dilute their capital. 

Banks with high CAR are ideal as it signifies that a bank has enough capital to withstand losses. Usually, a CAR of 8-12% is considered normal. 

6. Current Account Savings Account (CASA)

Current Account Savings Account or CASA Ratio refers to the share of current and saving account deposits out of the total deposits in a bank. A higher CASA is ideal as lower interest is paid on current and savings accounts.

A high CASA signifies better operating efficiency of the bank. A low CASA on the other hand means that the bank depends on costlier deposits which in turn hurts its profit-making margins. 

7. Return on Assets (ROA)

The Return on Assets shows us how profitable a bank is in using its assets to generate revenue. A high ROA is ideal. A low ROA means that the bank is not efficient enough in utilizing its assets to earn returns. 

Closing Thoughts

The ratios mentioned above are important to assess the health of the bank. One must assess a combination of ratios before taking any decision about the bank. While analyzing these ratios it is ideal to compare the ratios with others in the market to make the optimal choice. These ratios can be found in a company’s annual or quarterly reports.

That’s all for this post. Park your funds safely. Happy Investing!