Analyzing banks

Prof. Neerav Nagar

What do banks do?
• Facilitate the flow of funds from savers to
borrowers
How are banks different?
• Regulated
• Few fixed assets
• Few fixed costs
• Less equity, more debt
• Several liabilities are payable on demand or carry
short-term maturities
• Credit default and interest rate risks
Balance Sheet
Capital and liabilities
• Equity or preferred capital
• Reserves and surplus
• Deposits
• Demand deposits
• Savings bank deposits
• Term deposits
• Borrowings
• From the Reserve Bank of India (RBI)
• From others
• Other liabilities
Assets
• Cash and balances
• Cash in hand
• Balances with RBI
• Balances with banks
• Investments
• Government securities
• Shares
• Debentures
• Advances
• Short-term
• Long-term
• Fixed assets
• Other assets
Income Statement
Income
• Interest earned
• Advances
• Investments
• Balances with RBI and others
• Other income
• Commission, exchange and brokerage
• Profit/loss on sale of investments/assets
• Interest and dividend income
Expenses
• Interest expended
• Deposits
• RBI
• Inter-bank borrowings
• Operating expenses
• Provisions for loan losses
• Income taxes
Financial analysis
Income statement: Burden and
efficiency
• Interest income (II)
• Other income (OI)
• Interest expended (IE)
• Operating expenses (OE)
• Provisions for loan losses (PL)
• Income taxes (IT)

Net interest income (NII) = Interest income (II) –

Interest expended (IE)
Interest income
• Rate
• Duration of loan
• Creditworthiness of borrowers
• Type of industry
• Volume
• Earning assets/TA (EA/TA)
• Composition of earnings assets
Other income
• Type
• Fee
• Commission
• Profit/loss on sale of investments, etc.
• Frequency
• Recurring
• Non-recurring
Interest expended
• Rate
• Duration of deposits
• Own risk
• Market interest rates
• Volume
• Interest-bearing liabilities/TA (IBL/TA)
• Composition of interest-bearing liabilities
Operating expenses
• Salaries
• Rent
• Other overheads
Ratios
Efficiency
• Net Interest Margin = NII/EA
• Spread = II/EA – IE/IBL
• Burden ratio = (OE – OI)/TA
• Efficiency ratio = OE/(NII + OI)
Risk
• Leverage ratio = TA/Shareholders’ Equity (TA/SE)
• Loan ratio = Total loans/TA (TL/TA)
• Provision for loss ratio = PL/TL
• Loss ratio = Loan losses/TL
• Non-deposit borrowings ratio
= Non-deposit borrowings/Total assets
• Capital adequacy ratio = Capital/Risk weighted
assets
Liquidity
• Demand-to-time deposits ratio
= Demand deposits/Time deposits
• Cash-to-demand deposits ratio
= Cash and bank balances/Demand deposits
• Cash ratio = Cash/TA
DuPont analysis
Return on Equity (ROE) = Net Income/Shareholders’ Equity
ROE = NI/SE

ROE = Net Income * Average Total Assets

Average Total Assets Average Total Equity

ROE = ROA * Leverage

DuPont analysis

ROE = NI/(II+OI) * (II+OI)/TA * TA/SE

DuPont analysis
Net Income (NI) = II+OI-IE-OE-PL-IT

NI/TA = II/TA+OI/TA–IE/TA–OE/TA–PL/TA–IT/TA
CAMELS Ratings
• Capital adequacy
• Asset quality
• Management
• Earnings
• Liquidity
• Sensitivity to market risk

Source: Uniform Financial Institutions Rating System (Available at https://www.fdic.gov/regulations/laws/federal/ufir.pdf)