Ratios are important tools in fundamental analysis, and there are some ratios that are specifically designed to measure the profitability and efficiency of the banking sectors. These ratios are combinedly looked upon with the main ratios before measuring a bank’s performance and efficiency. There are some other financial aspects that have to be looked upon before investing in the banking sector, so these banking ratios cover the entire performance story of a bank or a financial institution.

  • 1- Operating Income

    Interest Income
    Interest income is a basic measure of earnings for banks and financial institutions.
    Interest income is the revenue generated by assets i.e. loans, mortgages, and securities.
    Banks generate a major portion of their interest income from mortgage loans, personal loans, and auto loans.
    Non Interest Income
    Non-interest income is derived primarily from fees including deposit and transaction fees, insufficient funds (NSF) fees, annual fees, monthly account service charges, inactivity fees, check and deposit slip fees, and so on.
    Banks charge fees that generate non-interest income as a way of increasing revenue and ensuring liquidity in the event of increased default rates.
     The primary source of Banks income is interest.
     Banks rely heavily on non-interest income when their interest rates are low.

  • 2- Net Interest Income -NII

    Net interest income is the difference between a bank’s interest income generated from the interest earned on its assets such as commercial loans, mortgage loans and securities over its liabilities such as interest paid out on the customer’s deposits.
    Net Interest Income = Interest Earned – Interest Paid
     Suppose XYZ ltd. Bank has earned an interest income of Rs. 9,000 Cr from its assets comprising all kinds of loans as like commercial loans, mortgage loans, Personal loans and securities and the bank has paid Rs. 6,000 Cr. as an interest to its depositors.
    So the Net Interest Income will be :
    Rs. 9,000 Cr ( Interest Earned ) – Rs. 6,000 Cr. ( Interest Paid ) = Rs 3,000 Cr (NII)
    Key values:
     NII can be more or less sensitive to the change in interest rates depending on its fixed rates or variable rates policy.
     Interest income depends on the type of loans offered by the bank. For an instance personal loan attracts much interest rate than the mortgage loans. However payment period of mortgage loans are comparatively much higher than personal loans.
     A rise in interest rate of savings / deposits can make interest expenses rise more than interest income, resulting in a drop in NII.
     Interest income also gets impacted by rise in the NPA’s.

  • 3- Net Interest Margin -NIM

    Net interest margin is a ratio to measure the difference between the interest income generated on assets such as loans by banks or other financial institutions and the interest paid on their liabilities such as deposits by them, relative to their amount of average interest earning assets.
    Net Interest Margin = (Interest Earned – Interest Paid) / Average Earning Assets
     Suppose XYZ ltd. Bank has earned an interest income of Rs. 700 Cr from its assets comprising all kinds of loans like commercial loans, mortgage loans, Personal loans, and securities and the bank has paid Rs. 400 Cr. as an interest to its depositor, and the average interest earning assets which include loans and other securities is Rs. 6,000 Cr.
    So the Net Interest Income Margin will be :
    Rs. 700 Cr ( Interest Earned ) – Rs. 400 Cr. ( Interest Paid ) / Rs. 6,000 Cr. ( Average Interest Earning Assets) = 5% (NIM)
    Key values:
    NIM is an indicator that calculates the profitability and growth of a bank or other financial institutions.
     NIM is usually expressed as a percentage of what the banks or financial institution earns on loans in a time period and other assets minus the interest paid on deposits or borrowed funds divided by the average amount of the assets on which they earn income in that time period.
     A positive NIM indicates the profitability of a bank, while a negative NIM shows the investment inefficiencies.
     It is a very good indicator to choose the bank stocks for value investing.
     But there are some limitations also as NIM only includes the interest incomes and expenses and excludes other incomes such as fees and other service charges and expenses like credit cost, facilities cost, etc.

  • 4- Cost To Income

    Cost to Income ratio is an important metric to evaluate a bank’s performance. It measures the operating cost of a bank to its operating income, which gives a clear picture of a bank’s profitability.
    Net Interest Margin = Operating Costs* / Operating Income**
    * Operating Costs includes (Employee cost + Other Expenses)
    ** Operating Income includes (Net Interest Income + Other Income)
     Suppose XYZ ltd. Bank has data in its balance sheet as :
    Operating costs = 11,000 Cr.
    Operating Income = 23,000 Cr.
    So, Cost to Income will be = (11,000 / 23,000) = 47.82 %
    Key values:
     Cost to Income ratio is an important ratio for evaluating a bank’s profitability.
     The lower the Cost to Income ratio, the more profitable a bank is considered to be.
     It also determines the potential problems of banks as, if the ratio increases from one period to another, it means that the costs/expenses are increasing at a higher rate as compared to the income.
     A higher Cost to Income ratio indicates that a bank is not managed very efficiently.
     Cost to Income ratio is very helpful for investors in choosing banks stocks, as it provides a clear view of the efficiency and profitability of a bank.  This ratio is also helpful in making a strategic decision to increase the income and decreases the expenses of financial institutions.
     An investor should compare the past data of this ratio before investing.

  • 5- Current Account Savings Account (CASA)

    CASA stands for the Current account and Saving account. The Current account, Saving account, and Term deposits are a major source of funds for a bank. The CASA ratio determines how much deposit a bank holds from the current accounts and saving accounts as compared to the total deposit.
    CASA Ratio = CASA Deposit / Total Deposit Example:
     Suppose XYZ ltd. Bank has deposits as :
    Total deposit = 9,000 Cr.
    & CASA deposit = 5,500 Cr.
    So, the CASA Ratio will be = (9,000 / 5,500) = 61.11%
    Key values:
    A higher CASA ratio means that a major portion of the total deposits or funds of the bank has come from the current and saving accounts, which are considered to be a cheap source of funds, as banks generally do not give any interest on current accounts and they give a mere 3-4% interest on the saving accounts.
     A higher CASA ratio means a bank is getting cheap funds which in turn will increase the net interest margin and also will increase the profitability of banks.
     A bank’s income depends on the interest income from loans, so for a better income, a bank needs cheap funds so that the margin of interest gets higher. That’s why CASA deposits are very important for banks.
     An investor compares the previous CASA ratio of a bank and also compares the CASA ratio of peer banks before investing.
     Banks do focus on attracting customers to open CASA accounts as these accounts generate deposits and give an edge to banks of cheap funds.

  • 6- Non-Performing Asset (NPA)

    Non-performing asset refers to those Loans or Advances that are in default or arrears. In other words, non-performing asset is a loan or advance for which the principal or interest payment is overdue for 90 days and more.
    NPA ratio = Net Non Performing Asset* / Advances**
    * Net Non-performing Asset = Gross NPA’S - Provisions
    ** Advances = Total amount of loan and advances given. Example:
     Suppose XYZ ltd. Bank has data in its balance sheet as :
    Net NPA = 900 Cr.
    Total Advances = 10,000 Cr.
    So, the NPA ratio will be = (1,200 / 10,000) = 1.20 %
    Key values:
    NPA ratio is an important ratio used by investors to gauge the financial health of a bank or financial institution as it determines the quality of assets a bank has, which in return is an important factor of bank earnings.
     The lower the NPA ratio is, the higher the credibility of a bank is.
     A significant number of NPA’s in the balance sheet of a bank may indicate the investors or regulators about the financial risk.
     A higher number of NPA ratios affect the net interest margins of the financial institution.
     An investor should compare the past data of the NPA ratio of a bank to measure the risk involved before investing.
     An investor should compare the peer NPA data also.
     An NPA ratio also tells about the policies of management of granting the loans/advances and also how efficiently they do secure the money of depositors and investors.

  • 7- Loans To Deposit Ratio - LDR

    The Loan to Deposit ratio is a liquidity ratio used to assess bank’s liquidity by comparing a bank’s total loan to its total deposit for a specific period.
    LDR Ratio = Total Loans / Total Deposit
    * Net Non-performing Asset = Gross NPA’S - Provisions
    ** Advances = Total amount of loan and advances given. Example:
     Suppose XYZ ltd. Bank has deposits as :
    Total Loans = 5,500 Cr. & Total Deposit = 7,000 Cr.
    So, the LDR Ratio will be = (5,500 / 7,000) = 0.78%
    Key values:
     A lower LDR ratio indicates that a bank has granted the loans or advances from its own deposits.
     While a higher ratio indicates that a bank has borrowed money from outside, to grant the loans and advances to the customers.
     If the ratio is too low it is considered that the bank‘s earning is not optimal as a very low amount of loans have been distributed.
     And if the ratio is too high it is considered that does not have enough liquidity to cover up the unexpected financial requirements or economic crisis.
     The LDR ratio determines the liquidity and also the financial health of a bank or financial institution.

  • 8- Capital Adequacy Ratio (CAR)

    Capital Adequacy Ratio is a metric to measure a bank’s capital in relation to its risk weighted assets and current liabilities. In other words, CAR is used to measure a bank’s financial strength using its capital and assets.
    Capital Adequacy Ratio = Tier 1 Capital* + Tier 2 Capital** / Risk Weighted Assets
    * Tier 1 Capital Includes = (paid up capital + statutory reserves + disclosed free reserves) - (equity investments in subsidiary + intangible assets + current & brought-forward losses)
    ** Tier 2 Capital Includes = A) Undisclosed Reserves + B) General Loss reserves + C) hybrid debt capital instruments and subordinated debts Example:
    Suppose XYZ ltd. Bank has data in its balance sheet as :
    Tier 1 capital = 10,000 Cr.
    Tier 2 capital = 5,000 Cr.
    & Risk Weighted Assets = 50,000 Cr.
    So, the CAR will be = (10,000 + 5,000 / 50,000) = 30.00%
    The Current norms to keep CAR is between 8-12% (varies in different categories).
    Key values:
    The regulatories of financial systems around the world keep a vigil eye on the CAR ratio to protect the depositors and promote the stability and efficiency of the financial system.
     The CAR determines the bank’s capacity to meet the current liabilities and other risks.
     An investor should assess the CAR before investing in the bank stock to be safeguarding his investment.
     Higher CAR is considered good as it tells an investor that the bank has sufficient funds to float in the market in terms of loans or assets to increase the income of the bank.