How to analyse banks

Summary: Ever wondered why bank stocks feel like a maze of numbers? This piece breaks down the must-know metrics that cut through the confusion. Perfect for spotting solid picks in India's booming banking scene.

In India, banks occupy a substantial portion of the overall stock market capitalisation, making them a key component in most equity portfolios, whether through mutual funds or direct investments. With credit penetration still low at around 60 per cent, financial firms enjoy a long growth runway ahead, boosting the appeal of banking stocks.​

However, analysing banks differs markedly from evaluating an FMCG or auto company for many reasons.

The financial statements of banks can prove a black hole. Lots of numbers lead to more confusion than clarity.

Unlike non-financial firms, where metrics like gross margin, working-capital cycle and debt to equity matter, banks demand unique indicators. To analyse a bank's financials, grasp these metrics first.

Use tools like Value Research's Stock Screener (Tool) or Top Rated Banks (Tool) for a better understanding.

In this story, we discuss essential metrics for researching banking firms.

Capital adequacy ratio (CAR)

It measures a bank's capital divided by risk-weighted loans. CAR safeguards depositors and financial stability, gauging the ability to meet obligations. Higher CAR means better capitalisation.

The RBI (Reserve Bank of India) requires 9 per cent CAR for scheduled commercial banks, emphasising 12 per cent for public-sector banks.​

Suppose XYZ Bank's CAR was -2.8 per cent in a quarter. This signals no capital buffer for bad loan losses.

Gross and net non-performing assets

NPAs (non-performing assets) flag loans at repayment risk, turning non-performing after 90 days overdue. Gross NPA covers principal and interest; net NPA deducts provisions from gross.

Provision coverage ratio

Some loans inevitably sour, so banks provision by reserving profits against bad assets. PCR at 70 per cent means funds cover 70 per cent of those NPAs. High PCR shows resolved asset issues.

Return on assets

Loans are assets, deposits are liabilities. ROA (net profit/total assets) reveals asset profitability. A high ROA may reflect other income, lending aggression, or efficiency.

CASA ratio

Current and Savings Account deposits yield low interest. High CASA cuts overall costs positively.

Net interest margin

The difference between lending interest income and deposit costs, relative to earning assets, is a profitability gauge like corporate gross margins.

Cost to income

Operating expenses divided by operating income (interest + other). Lower ratio boosts profitability via efficiency.

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