Three measures to gauge a bank's financial health2 min read . Updated: 18 Nov 2020, 01:38 PM IST
- Large, well-run private sector banks tend to have gross NPAs sub-5%. Investors, however, should be cautious as the classification of bad loans can sometimes fail to give a true picture. For a clearer picture, one can look at net NPA ratio
MUMBAI: The Reserve Bank of India on tueday placed Lakshmi Vilas Bank under moratorium and announced its merging with DBS Bank. Withdrawals have been capped at ₹25,000 per depositors, with exceptions such as medical emergencies in which case the limit is ₹5 lakh per person. While such moratoriums are rare and come as a surprise, the bank's financial parameters have been available in the public domain.
In this piece we look at what are the metrics to look for to gauge a bank’s financial health. These are metrics are easily available in quarterly results uploaded on a bank's website.
Capital Adequacy Ratio
This data point captures the buffer a bank has against bad loans. When defaults happen, the losses are absorbed by the bank’s capital rather than that of depositors' and this reading reveals the extent of the loss absorption capacity available with a lender.
"A ratio above 12% connotes a healthy bank. As per RBI norms, the minimum capital adequacy ratio has to be 9% for a scheduled commercial bank," said Kirtan Shah, chief financial planner at Sykes and Ray Equities (I) Ltd., a mutual fund distributor. In the case of Lakshmi Vilas Bank, the unaudited results for July-September quarter revealed a capital adequacy ratio of -2.85%, far below what is considered healthy.
Gross Non Performing Asset (NPA) Ratio
This tells us about the proportion of a bank’s loans gone bad. Large, well-run private sector banks tend to have gross NPAs below 5%. However investors should be cautious with this as the classification of bad loans can sometimes fail to give a true picture.
"Gross NPAs can be understated if a bank is restructuring loans aggressively, so take it with a pinch of salt," said Shah.
For Lakshmi Vilas Bank, gross NPAs stood at a huge 24.45%. For a clearer picture, one can look at the net NPA ratio which factors in provisions--money set aside--for bad loans. This ratio stood at 7.01% for Lakshmi Vilas Bank.
This is the total value of all the shares of the bank. It changes every day with the bank's stock price. This makes it a more up-to-date indicator of a bank’s financial health compared to quarterly or annual results. It can also reveal problems with the numbers.
According to Shah, a decline in market cap, even as the reported numbers look good, can tell you that the market is sceptical of numbers.
Some financial advisors ask investors to stick to scheduled commercial banks (SCBs) only or even steer away from all except the largest few banks. "I don't think investors should take any kind of risk with their choice of banks. For higher returns there are products like mutual funds. I would recommend that investors restrict themselves to the biggest 3 PSU banks and largest 3 private sector banks. Banks should be looked at only for keeping our money safe, liquid and for ease of transactions," said Kalpesh Ashar, founder, Full Circle Financial Planners and Advisors, a Sebi-registered investment advisor.
However, investors who are looking at mid-sized or small banks for higher returns on their fixed deposits (FDs) can track the metrics mentioned above.