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In this article I will take you through the basics of a banks balance sheet.
Assets
Cash
Investments
- SLR
Rs. In cr. %
336
Liabilities
Rs. In cr.
731
12
719
120
2.1% Deposits
3090
229
4.1% - Savings
935
404
Advances
Fixed assets
433
7.7% Borrowings
1454
Other liabilities
Total
5635
100% Total
360
5635
This data is taken from the September 2013 disclosures of ICICI Bank.
Borrowings are made up of bonds, debentures and certificates of deposit where the
bank borrows money of varying tenor.
One should look at the deposits and borrowings from the perspective of respective
interest rates and corresponding cash inflow and outflow for the bank. If you were the
owner of a bank you would like to pay the least amount of money on your deposits
and borrowings.
Rs. In cr.
- Others
1751.38
56.7%
- Savings
935.35
30.3%
- Current
403.73
13.1%
3090.46
100.0%
Total
goes above 1, investors get cautious. Figures above 1.5 indicate cause for worry.
Now, consider the debt to equity ratio in a bank.
Look at ICICI Banks leverage.
I add the Deposits and Borrowings together and get a figure of Rs. 4544 cr.
Divide this by the Net Worth of Rs. 731 cr and we get a D/E ratio of 6.2.
If you have not seen a bank balance sheet before this will seem shocking. This would
never be seen in typical manufacturing companies. Not even in normal infrastructure
or project finance cases which can see high debt equity ratios of 3:1.
This is the reason why banks are regulated by the central bank, the RBI. They operate
with very high leverage as compared to companies in other industry sectors.
Any company operating with high leverage usually has less room for error. Leverage is
a double edged sword. It can give you high returns or high losses. All banks live by this
rule.
So, we come back to the NPA issue.
Consider the balance sheet shown above. Suppose that 2% of the advances on this
balance sheet go bad and end up as NPAs because the borrowers cannot make
payments to the bank.
2% of Advances works out to around Rs. 64 crore. This seems like a small amount. Let
us compare this Rs. 64 crore to the shareholders capital in the bank, also the book
value. Book value stands at Rs. 731 crore.
2% NPAs work out to 8.7% of ICICI Banks book value or net worth.
You will now appreciate that the NPA numbers in the headlines seem low. When you
re-frame the context as damage to book value you get the true picture.
Presently, the banking sector is facing stress as a slowing economy puts pressure on
borrowers, with some defaulting. Private and public sector banks are seeing rising
NPA levels. PSU banks are comparatively harder hit as they are widely believed to
have deficient lending standards as compared to their private sector counterparts.
This recent article in the Hindu Businessline talks of the problem of rising bad loans.
If there is a hole in the balance sheet, it has to be filled. One way it can be filled up is
with the profits left after paying dividends. In bad times profit growth reduces so it
does not help the situation to a great extent.
The other usual way is to raise equity capital.
This dilution is a big risk to a bank investor. The earnings now get distributed over a
larger number of shares and thus earnings per share (EPS) is affected negatively.
A bank that has bad loans and attendant capital problems cannot grow its loan book
as well as healthy counterparts. This is because they face regulatory pressure.
This brings us to the next topic.
assets. This is because banks are systemically important institutions. If one bank sees
trouble, contagion spreads in the financial system because of the financial interlinkages. We have seen this happening in the 2008 credit crisis in the global economy.
The regulator places different types of assets in different buckets depending on how
risky they are. Different buckets have different risk weights to quantify the risk.
For example if the bank has parked money in Government Securities they are given
zero risk weight. Check the risk weights set by the RBI for housing loans.
In ICICI Banks case, as of the quarter ending of September 2013, their risk weighted
assets (on balance sheet and off balance sheet) are Rs. 4971 crore.
The total capital (calculations based on RBI stipulated rules) as of September 2013
stands at Rs. 820 cr.
Capital adequacy ratio (CAR) is total capital divided by total risk weighted assets. This
works out to 16.50% as of September 2013.
Take CAR to be a sign of relative safety. The RBI stipulates that the CAR should be at
least 9%.
Bad loans bring down the CAR of a bank reducing room to grow advances. As an
investor you will want the bank to have a high capital adequacy ratio.
Continue reading
Read the next article andunderstand a banks income statement (or profit and loss
statement) in in the series on understanding bank stocks. After that I will write an
article in which I will describe how to look at the complete financials of a bank and
how to value banks.
Hope you had a good time reading this article on bank balance sheets. Let me know
your views.
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