Investors should look at the publicly available information for the listed banks before putting in their money
With speculations around the functioning of RBL Bank, the Reserve Bank of India (RBI) recently released a statement stating that the bank is well capitalized and the financial position of the bank remains satisfactory and there is no need for depositors and other stakeholders to react. It also mentioned that the bank has maintained a comfortable capital adequacy ratio, provision coverage ratio and liquidity coverage ratio. Here, we decode these ratios, what it means to deposit holders and the comfortable levels at which a depositor can feel safe about their investments.
Is there adequate capital?
Bank should have enough capital to absorb any losses arising from the risks in its business. One of the main reasons to ensure it is that the money borrowed from depositors and other lenders is not impacted.
One of the key ratios to see whether a bank has enough capital is capital adequacy ratio. This is calculated by dividing available capital by the risk weighted assets; the balance sheet assets of banks (loans given by banks and other investments) are assigned certain risk weights. Banks must maintain minimum capital funds at a prescribed ratio so that it is able to absorb any losses incurred from these assets. So, higher the ratio, the better it is.
Raj Khosla, founder and managing director at My Money Mantra, said, “As per the RBI norms, the minimum capital adequacy ratio that banks must maintain is around 10%. However, most banks maintain capital much higher than that. With higher capitalization, banks can better withstand episodes of financial stress in the economy."
Are bad loans accounted for?
When the borrowers default on their loan repayments for 90 days or more, the bank classifies that loan as a non-performing asset (NPA). Thus, higher NPA ratio is one of the warning signs of the weak asset quality of the bank. To avoid getting impacted by such NPAs, banks are advised to build up provisioning—to set aside some amount—in good times, when the profits are good, which can be used for absorbing losses in a downturn.
To check this, one can use Provisioning Coverage Ratio (PCR), which is essentially the ratio of provisioning to gross non-performing assets. This indicates the extent of funds a bank has kept aside to cover loan losses.
Yuvraj Choudhary, analyst, Anand Rathi Shares and Stock Brokers, said that “it usually depends on bank to bank. But generally, anything above 50-60% is considered decent".
Does it have high liquid assets?
To assess whether the bank can withstand cash outflows in stressed conditions, the Basel Committee, an international committee formed to develop standards for banking regulation, had introduced Liquid Coverage Ratio (LCR) as part of post Global Financial Crisis (GFC) reforms.
It requires banks to maintain High Quality Liquid Assets (HQLAs) to meet 30 days net outgo under stressed conditions. It is calculated by dividing HQLAs to total net cash outflows over the next 30 calendar days. Indian banks are required to maintain LCR of 100%. Anything higher is a positive.
Note that not all banks may provide this information periodically.
Diversify your FD investment
The Deposit Insurance and Credit Guarantee Corporation (DICGC) insures deposits up to a maximum of ₹5 lakh for both principal and interest amount. The change in law last year that the liability of DICGC kicks in when any direction, order or scheme is passed against the bank prohibiting the depositors of the insured bank from accessing their deposits is a welcome move. Earlier, the trigger was liquidation or the cancellation of a bank’s licence. This provides some comfort to depositors.
Having said that, understanding key ratios that reflect the financial health of a bank helps investors not to panic due to speculative news. Further, Vidya Bala, co-founder, PrimeInvestor.in, said, “Investors typically look for interest rates when they put money in deposits. Higher interest rates can be provided only if banks are taking risks in other ways. It is important for investors to look at the publicly available information at least for listed banks before putting their money. The ratios of bigger banks such as ICICI Bank and HDFC Bank can be considered as benchmark to assess smaller banks."
She also added that if investors are parking a big chunk of money, it is good to have at least some portion of the investment in at least one of the systematically important banks—the banks which are not allowed to fail—irrespective of the interest rate. Currently, SBI, ICICI Bank and HDFC Bank are identified as systematically important banks. It is also important not to look at these metrics in isolation. Choudhary added that whenever any of the metrics is below the mandated level, the RBI will step in and take necessary action. When the investment is too large, it is recommended to periodically check the data published by the banks. A combination of weak metrics shall guide as a warning sign of weak financial position of the bank.