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What are ratios to analyse any banking stocks

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NSE:HDFCBANK   HDFC BANK
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Today we will study ratios for analysing any banking/ non- banking stock.
Key Ratios are -
1. Net Interest Margin (NIM)
2. Provision Non Performing Assets (PNPA)
3. Loan to Assets Ratio
4. Return on Assets Ratio (ROA)
5. Capital Adequacy Ratio
6. Gross NPA
7. Net NPA
8. CASA Ratio
9. Cost to Income ratio
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1. Net Interest Margin (NIM)
1. Net Interest Margin = ( Investment Income –
Interest Expenses ) / Average Earning Assets.
2. Positive Net Interest Margin shows that bank is earning more money in the form of interest than its cost of funding investments.
3. There are several factors that affect bank NIM. One of the most significant is interest rates. When interest rates are high, banks are able to earn more from loans and investments, which increases their NIM. When interest rates low, banks earning will loans and investments decrease, which lead lower NIM.
4. In summary, Net Interest Margin is important measure of bank's profitability and its ability to generate income from its existing assets. NIM is affected by interest rates and competition. Banks with a high NIM are generally considered strong financial position and better to grow and invest in new opportunities.

Let's look at example
Bank in India has total assets of ₹1,00,000 crore consist of loans and investments. The bank has total deposits of ₹80,000 crore and it pays interest rate of 4% on savings accounts and 6% on Fix Deposit The bank total interest income for the period is ₹2,400 crore which is earned by loans and investments. The bank total interest expense for period is ₹1,600 crore, which is paid to depositors.

To check the NIM we take the bank net interest income (NII) of ₹800 crore (₹2,400 crore in interest income - ₹1,600 crore interest expense) and divide by the bank average earning assets of ₹90,000 crore (average of total assets and total deposits).
NIM = NII / Average Earning Assets
NIM = ₹800 crore / ₹90,000 crore
NIM = 0.89%
Bank NIM is 0.89% every ₹100 of assets the bank is earning ₹0.89 of net interest income. This NIM is a measure of the bank efficiency in generating income from assets and can be used to compare it with other banks and over time.
NIM in India will be lower than developed countries due to lower lending rates and high competition among bank.
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2. Provision Non Performing Assets (PNPA)
1. An asset, including a leased asset, becomes non performing when it ceases to generate income for the bank.
2. Provision for Non Performing Assets (NPA). The amount keep aside by bank, to cover it's potential losses from loans and other credit related assets that have been non performing.These provisions are made when a bank expects that some of its borrowers will default on their loans, and the bank needs to set aside funds to cover the potential loss.
3. In summary, Provision for Non Performing Assets (NPA) Banks are required to make provisions for NPA on a regular basis, quarterly basis, amount of provisions is disclosed in the financial statements. Provision for NPA is an important measure of a bank's financial health, Help bank to absorb the impact of loan defaults and manage credit risk.
Provisions for NPA is closely watched by investors, analysts, and regulators, it helps them to assess the bank's credit risk.

Let's look at example
Bank total loans of ₹50,000 crore. ₹2,000 crore classified Non performing Assets (NPA) borrowers defaulted their payments more than 90 days. Bank required to set aside certain percentage of the NPA loans as PNPA as per the Reserve Bank of India's guidelines. The current PNPA provisioning ratio is 15%.
To get PNPA we multiply the NPA loans of ₹2,000 crore with the PNPA provisioning ratio of 15%.
PNPA = NPA loans x PNPA provisioning ratio
PNPA = INR 2,000 crore x 15%
PNPA = INR 300 crore
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3. Loan to Assets Ratio
1. Loan to Assets ratio can help investors obtain complete analysis of bank's operations. Banks that have relatively higher Loan to Assets ratio banks with lower levels of Loan to Assets ratios derive a relatively larger portion of their total incomes from more diversified, noninterest earning sources, such as asset management or trading. Banks with lower Loan to Assets ratios may fare better when interest rates are low or credit is tight.
2. In summary, Loan to Asset ratio is financial metric compares bank total loans to total assets. It's used to measure bank leverage assess the level of risk associated with lending activities. Higher Loan to Assets ratio indicates that a bank is more heavily reliant on lending and is more leveraged and risky, while a lower ratio indicates that the bank is less risky.

Let's look at example
Bank has total assets ₹1,00,000 crore, total loans ₹70,000 crore. to get Loan to Assets Ratio we divide the total loans by the total assets.
Loan to Asset Ratio = Total Loans / Total Assets
Loan to Asset Ratio = ₹70,000 crore / ₹1,00,000 crore. Loan to Asset Ratio = 0.7.
Bank's Loan to Assets Ratio is 0.7 / 70% (0.7*100) bank assets in form of loans. A higher Ratio indicates that bank is heavily invested in lending activities, which can be sign of more aggressive lending strategy. it's also increases the risk of default. Than higher risk of NPA. Banks required to maintain minimum level of Capital Adequacy Ratio as per the Reserve Bank of India's (RBI) guidelines.
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4. Return on Assets Ratio (ROA)
1. Return on Assets = Net Income / Total Assets
2. The higher ratio means assets are well managed and low ratio means resources didn't used effectively compared to the industry and competitors.
3. In summary, ROA is financial ratio measures profitability of company in relation to total assets. It is calculated by dividing the company's
net income by its total assets. This ratio is useful to compare the performance of company with its peers in the same industry. It is an important metric used to evaluate a company's overall efficiency and performance but it's important to keep in mind that high ROA not necessarily mean that company have strong financial position.

Let's look at example
Bank has total assets of ₹100 billion and net income of ₹5 billion. To get ROA we divide the net income by total assets.
ROA = Net Income / Total Assets
ROA = ₹5 billion / ₹100 billion
ROA = 0.05 or 5%.
Bank ROA is 5% For every ₹100 billion of assets, the bank generates ₹5 billion of net income. Higher ROA show that bank is profitable and efficient in utilizing assets. It's important to note this ratio is sensitive to the size of the bank It's better to compare the ROA of a bank with other banks of similar size.
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5. Capital Adequacy Ratio
1. The Capital Adequacy Ratio helps make sure banks have enough capital to protect depositors money.
2. Banks are required to maintain a certain level of Capital Adequacy Ratio as per the regulations set by central bank to ensure that they have sufficient capital to meet the potential losses and continue their operations even in adverse situations.
3. It helps maintain the stability of the financial system by ensuring that banks can withstand in unexpected situation.

Let's look at example
In India, the Reserve Bank of India (RBI) sets the minimum Capital Adequacy Ratio for banks at 9%. which means that they must hold capital worth at least 9% of their total risk-weighted assets.
Bank in India with total assets of ₹‎100 billion and risk-weighted assets of ₹‎80 billion must maintain minimum capital of ₹‎7.2 billion (9% of ₹‎80 billion) to meet the Capital Adequacy Ratio requirement set by the RBI.
It's important to note that, the Banks with a higher Capital Adequacy Ratio are considered to have a better ability to absorb unexpected losses.
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6. Gross NPA
1. Gross Non Performing Assets (GNPA) is refer to the total value of loans or advances that have been classified as Non Performing Assets. These are loans or advances the borrower has defaulted on repayment or interest for certain time. loan is classified as an NPA if the borrower has not made any payment for period of 90 days or more.
2. A high ratio of GNPA to total loans indicates a higher level of credit risk and potentially weaker financial condition for the bank.

Let's look at example
Bank has total loans of ₹‎100 billion and ₹‎20 billion are classified Non Performing Assets (NPA). The bank Gross Non Performing Assets (GNPA) would be INR 20 billion.
we see the ratio of GNPA to total loans we get 0.2 (₹‎20 billion / ₹‎100 billion). This ratio of 20% indicates that 20% of the bank loans are classified as NPA. This high ratio may indicate the bank is facing high level of credit risk it could be cause for concern.
It's important to note that Gross NPA ratio is used in conjunction with other financial indicators to understand overall financial health of bank and single indicator may not enough to make a conclusion.
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7. Net NPA
1. Any financial security owned by a bank is considered an asset. The interest we pay on loans is the primary source of income for banks these loans are classified as assets for bank's.
when borrowers can't repay the amount these assets are classified as Non Performing Assets (NPA) because they are not generating any income for the bank's.
2.If loan provided by bank is overdue more than 90 days from the borrower end comes under NPA. If loan amount is unpaid more than 1 year from due date then it's a doubtful debt and if it’s unpaid more than 3 years then loss of an asset or default account.

Net Non-Performing Asset = Gross NPA – Provisions.

Gross NPA = Total Gross NPA/Total Loans given.


Impact of NPA
Due to higher NPA rates, banks will suffer significant revenue losses that will potentially affect their brand image. insufficient funds, banks will have to increase the interest rates on loans to maintain their profit margin.

Let's look at example
Bank has total loans of ₹100 billion and ₹20 billion are classified as Non Performing Assets (NPA). The bank is required to make provisions for ₹10 billion against these NPA. The bank Gross Non-Performing Assets (GNPA) would be ₹20 billion and Net Non Performing Assets (Net NPA) would be ₹10 billion (₹20 billion - ₹10 billion).
If we see the ratio of Net NPA to total loans we get 0.1 (INR 10 billion / INR 100 billion). This ratio of 10% indicates that 10% of the bank's loans classified as NPA after making necessary provisioning. This ratio gives a clearer picture of bank's financial health than just Gross NPA ratio as it takes into account the provisions made against NPA.
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8. CASA Ratio
1. CASA (Current Account and Saving Account) it is measure the proportion of bank deposits that are in the form of current and savings accounts.
2. The ratio is calculated by dividing the total value of current and savings account deposits by the total deposits. It is typically expressed as percentage. Higher CASA ratio indicates that bank have larger proportion of stable deposits. This is because banks can use these deposits to fund their lending activities at a lower cost which improves bank's net interest margin.

Let's look at example
Bank has total deposits of ₹200 billion and ₹150 billion in form of current and savings accounts. The bank CASA ratio would be 75%.
This ratio indicates that three fourth of the bank deposits are in the form of current and savings accounts which are considered the stable form of deposits. This high ratio is considered positive sign. Stable deposits can used to fund lending activities lower cost.
High CASA ratio the bank will have access to cheaper funding which will improve it's net interest margin. This means that the bank will be able to offer loans at a lower rate of interest. which will make it more competitive in the market and attract more customers. And bank will also have more stable funding which will make it less vulnerable to market fluctuations and interest rate changes.
Asset quality, capital adequacy play important roles in assessing a bank's overall financial condition.
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9. Cost to Income ratio
1. Cost to Income Ratio (CIR) measure company efficiency by comparing it's operating expenses to it's revenue. calculated by dividing the total operating expenses by the total revenue and expressed in percentage.
2. Lower (CIR) indicates that company more efficient in managing expenses and able to generate more income for every unit of expenses. while higher (CIR) indicates that company less efficient in managing it's expenses and is generating less income for every unit of expenses.

Let's look at example
Bank A with a high CIR.
Bank has total operating expenses of ₹10 billion and total revenue of ₹15 billion. The bank's CIR is 67% (₹10 billion / ₹15 billion). High CIR indicates that the bank is not very efficient in managing its expenses and is generating less income for every unit of expenses. The bank may need to review its cost structure and implement measures to reduce expenses in order to increase its efficiency and profitability.

Bank B with a low CIR:
A bank has total operating expenses of ₹5 billion and total revenue of ₹15 billion. The bank CIR is 33% (₹5 billion / ₹15 billion). This low CIR indicates that the bank is efficient in managing its expenses and is able to generate more income for every unit of expenses. The bank able to invest in growth opportunities and increase profitability.

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