Investing in the stock markets is only as successful as your due diligence in conducting research and analysis before going forward with the investment. One of the most critical aspects of designing an investment strategy is determining which stocks are performing well along with the diversification of portfolios. This is where one of the historically strongest stocks come into the picture- the banking stocks.
Most retail investors have banking stocks in their portfolios. Banks and financial institutions have significant free floats that give investors a sense of security and profitability in the stock market. However, with limited access to credit in India, financial companies still have a long way to go. This is reflected in the expanding popularity of banking and financial stocks.
Yet, a bank stock’s credibility differs significantly from the review of everyday companies or traditional industrial stocks. Unlike non-financial corporations, where metrics such as working capital cycle, gross margin and leverage are essential to analyse, banking stocks need to be analysed using completely different parameters.
Reading bank statements and documents as part of the fundamental analysis can be a dexterous task. Too many numbers cause more confusion than a clear understanding. And that is what we are here to discuss. To analyse a bank’s monetary statements, one needs to know the following metrics.
Current Account Savings account (CASA) Ratio
The Current Account Savings (CASA) ratio is the ratio of total bank deposits in current and savings accounts to net deposits of a bank. It is generally used to ascertain how much money is in a bank in the form of savings account and current account deposits.
A high CASA ratio signifies that most bank deposits are liquid and linked to current and savings deposits. If a bank’s CASA rate is high, it usually shows that the net interest margin is very high, which means that the bank has an excellent operating capacity model. A high CASA ratio is what investors should look for before investing in a banking stock.
Net Interest Margin for accessing a banking stock
The Net Interest Margin (NIM) is the differentiated value between total expenses and the net interest income. It is usually defined as a percentage of average fixed-income assets. The net interest margin measures the profitability of a bank’s investments. It considers the interest a bank makes on its securities and loans, subtracts the interest payable on debt and deposits, and divides it across the value of those securities and loans. For investors looking to invest in banking stocks, a higher net interest rate is desirable.
Non-performing Assets
Non-performing assets (NPAs) determine the risk of loans repayment by debtors to a bank. If no interest or instalment of the principal amount is paid for 90 days, the loan becomes a non-performing asset. NPAs are divided into gross and net non-performing assets. Gross NPA covers the principal and interest on total debt, and net NPA is calculated primarily by deducting bank provisions from all bad loans under Gross NPA.
Credit problems and non-performing assets have threatened Indian state-owned banks in recent years. The State Bank of India, India’s largest public sector bank, recorded 11% of its debt as outstanding loans as NPA in 2018. Investors should consider a bank with low or no NPAs before investing in its stock.
Cost of Liabilities and banking stock relation
Banks carry out different types of activities. But they majorly make money from loaning money to debtors. Simultaneous to banks’ lending activities, the interest payments on the deposits form a significant part of their operating expenses. Thus, deposits are a bank’s liabilities as there is an interest cost they must pay on these deposits.
The banks also need funds to function correctly. For that, it must borrow other than the received deposits. These borrowings usually come from the Reserve Bank of India, other institutions, banks, bonds, etc. Any borrowings carry an interest component that needs to be paid at regular intervals without fail. This interest component that a bank needs to pay is a part of the Cost of Liabilities.
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Cost of liabilities helps an investor get an idea of how much the borrowings cost to the banks. It reflects the cumulative rate a bank pays on its debt.
The lower the cost on the liabilities, the better it is for the banks as it will increase the margins and hence increase the profitability. A high liability price is generally considered bad for a company as it will reduce the margins and increase the company’s interest-paying obligation.
Capital Adequacy Ratio (CAR)
The capital adequacy ratio (CAR) calculates a bank’s available capital divided by the loans sanctioned by the bank. CAR helps estimate the financial strength or capability of the financial institution to meet its responsibilities by using its assets and resources.
A higher the CAR is indicative of a better capitalised bank. In India, as per the RBI norms, Indian-scheduled commercial banks are expected to maintain a CAR of 9 per cent, while Indian public-sector banks are stressed to keep a CAR of 12 per cent.
A bank with a CAR is above the minimum qualifications needed to suggest stability. Therefore, the higher a bank’s CAR, the more likely it is to endure a financial downturn, and thus, it is a good banking stock to buy-in.
