10 Useful Parameters to Analyze a Banking Stock
Banking Sector Analysis
How can one analyse banking stocks? Which are the 10 parameters to be looked at or useful to analyze a Banking Stock (from the point of investments)? Which factors should be given importance when analysing banking stocks or a bank (from the point of investments)?
This is what we will be discussing in this article.
10 Parameters Used To Analyze A Banking Stock
Let’s have a look at the parameters to analyze a Banking Stock.
1.Net Interest Income (NII)
- Net Interest Income (NII) is the total revenue generated by a bank from lending and other interest-earning activities minus all interest expenses.
- Banking is a business of borrowing and lending. The bank has to pay interest on the borrowed money and it earns interest on the money it has lent. So, the difference between the interest amount earned by the bank and interest payments made, is the Net Interest Income of that bank.
- Or one can also alternatively look at Net Interest Margin which also gives out almost same information as Net Interest Income. Net Interest Margin (NIM) is a profitability ratio. It measures how well a company is making investment decisions by comparing the income, expenses and debt of these investments.
- Net Interest Margin is interest on advances given out minus the deposits received divided by the total amount of money invested.
- The more the NII or NIM of a bank the better the bank is performing.
- For Deposits there are 3 types of instruments which are Current Account, Savings Account and Fixed Deposit (Term Deposit).
- Total Deposits is the sum of the amount of money deposited by the customers of that bank in those 3 instruments.
- Total Deposits are considered as Retail Liabilities by the bank.
- Advances are nothing but the loans given out by the bank on which they receive interest. The sum of total number of or the total amount of loans given out is taken as Total Advances.
- Total Advances are considered as Assets by the bank.
4.Total Balance Sheet
- A Balance Sheet is a financial statement that reports a company’s assets and liabilities. In short, it represents the total business size of the bank.
- One should always know what are the assets to the bank and what are the liabilities of the bank.
5.Capital Adequacy Ratio (CAR)
- Capital Adequacy Ratio measures the ability of a financial institution to meet its requirements by comparing its capital to its assets. Regulatory authorities monitor this ratio to see if any financial institutions are at risk of failure.
- When a bank borrows Rs. 100, it does not lend the whole Rs. 100. There are many rules and regulations, made by the RBI, owing to which the bank has to also some part of the money in the Government securities as well.
- The CAR of private banks is generally high, usually above 15%. On the other hand, the CAR number is low, as they just match the minimum requirements stated by the RBI.
- The higher the Capital Adequacy Ratio (CAR), the more the bank is performing on the safer side.
6. Gross NPA and Net NPA
- This is a very important parameter. One should always look out for these numbers and how they change with time.
- A Non-Performing Asset (NPA) refers to a sorting for loans or advances that are in default in scheduled payments of principal or interest. In most cases, debt is classified as non-performing when loan payments have not been made in the period agreed upon.
- Gross NPA refers to the sum of all the unpaid loans or advances which are classified as non-performing assets.
- And Net NPA refers to the sum of the non-performing assets less provision for bad and doubtful debts.
- The lesser the Gross NPA and Net NPA numbers are, the more better the bank is. One should look at the way the NPA numbers go up and down. The way the bank handles these numbers and books these numbers should be looked at very closely.
- Current Account and Savings Account means CASA. CASA deposit is the amount of money that gets deposited in the current and savings accounts of bank customers. Since interest rates are lower than term deposits (0% interest on Current account and 4%-6% on Savings account), CASA is the cheapest and major source of funds for banks.
- As the CASA ratio reflects the bank’s capacity to raise money with lower borrowing costs, financial experts also look at CASA ratio to understand a bank’s financial health.
- This number has a direct relation with Net Interest Margin. Where the proportion of CASA is high, there the NIM is on the higher side.
- Banks has some business segments within itself. So, segmental revenue is nothing but the classification of the total revenue amount in to the various segments of the bank.
- The segments from which the banks earns revenue are Treasury, Balance Sheet Management Unit & Corporate Centre, Retail Banking and Wholesale (corporate) banking, Third Party Products Income (mutual fund distribution, insurance distribution, Forex income).
- One should always look at the core business of the bank, retail and wholesale banking. The proportion of these 2 in the bank’s total revenue should always be very healthy.
9.Retail v/s Wholesale
- Amongst wholesale and retail, if the proportion of retail banking is the most then it is the best.
- With retail banking there is lower risk of NPA’s. In wholesale banking even if one or two major companies default, then the NPA number can shoot up. For example, HDFC bank and Kotak Mahindra Bank are more retail oriented and thus haven’t faced any major NPS issues till now, On the other hand, everyone knows, ICICI bank, Yes bank, SBI and Axis bank, which are wholesale oriented, have faced some major NPA issues in the last year.
- The presence of the bank across India should be evenly balanced.
- The Urban v/s Rural presence should be looked at of the bank. The government has strong focus now on rural economy and development. So, the opportunities from rural markets are about t increase, and if the banks already have their presence in that market then the banks can be advantage.
- Current, PSU banks have more presence in rural market as compared to private banks. But still ICIC bank and HDFC bank are making efforts to break into this market.
- Thus, when we analyze a banking stock of any bank for investment purposes, then these 10 parameters should definitely be analysed first.
- Instead of looking just at current numbers, they should also be compared with their historical numbers. This will give an understanding on whether those numbers have improved or not.