What is a CRR rate?

Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with RBI. If RBI decides to increase the percent of
this, the available amount with the banks comes down. RBI is using this method (increase of CRR rate), to drain out the excessive
money from the banks.
What is a Bank Rate?
Bank rate is the rate at which RBI gives to the commercial banks. Whenever RBI increases its rates, the effect will be shown on the
commercial banks. In this case, the commercial banks have to increase the interest rates for their profits.
What is a Repo Rate?
Whenever the banks have any shortage of funds they can borrow it from RBI. Repo rate is the rate at which our banks borrow
rupees from RBI. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases
borrowing from RBI becomes more expensive.
What is a Reverse Repo Rate?
Reverse Repo rate is the rate at which Reserve Bank of India (RBI) borrows money from banks. Banks are always happy to lend
money to RBI since their money are in safe hands with a good interest. An increase in Reverse repo rate can cause the banks to
transfer more funds to RBI due to this attractive interest rates. It can cause the money to be drawn out of the banking system. 
Due to this fine tuning of RBI using its tools of CRR, Bank Rate, Repo Rate and Reverse Repo rate our banks adjust their lending or
investment rates for common man.
Difference between Bank Rate and Repo Rate

While repo rate is a short-term measure, i.e. applicable to short-term loans and used for controlling the
amount of money in the market, bank rate is a long-term measure and is governed by the long-term
monetary policies of the governing bank concerned.

Bank rate, also referred to as the discount rate, is the rate of interest which a central bank charges on the
loans and advances that it extends to commercial banks and other financial intermediaries. Changes in
the bank rate are often used by central banks to control the Money supply

current bank rate at which RBI lends to Banks is 6%.

Repo rate Whenever the banks have any shortage of funds they can borrow it from RBI. Repo rate is the
rate at which our banks borrow rupees from RBI. A reduction in the repo rate will help banks to get Money
at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive.

current repo rate is 4.75% (As these rates keep changing to know the current rates please
visit http://www.rbi.org.in/home.aspx and see the Current Rates at right hand side of the page)

The Reverse repo rate is the rate at which the RBI borrows from the banks, while the bank rate is the rate
at which the banks borrow from the RBI

Statutory Liquidity Ratio

SLR (Statutory Liquidity Ratio) is the amount a

commercial bank needs to maintain in the form of cash,
or gold or govt. approved securities (Bonds) before
providing credit to its customers. SLR rate is determined
and maintained by the RBI (Reserve Bank of India) in
order to control the expansion of bank credit.

How is SLR determined?

SLR is determined as the percentage of total demand and
percentage of time liabilities. Time Liabilities are the
liabilities a commercial bank liable to pay to the customers
 on their anytime demand. .

What is the Need of SLR?

With the SLR (Statutory Liquidity Ratio), the RBI can ensure the solvency a commercial bank. It is also helpful to
control the expansion of Bank Credits. By changing the SLR rates, RBI can increase or decrease bank credit
expansion. Also through SLR, RBI compels the commercial banks to invest in government securities like
government bonds..

SLR to Control Inflation and propel growth

SLR is used to control inflation and propel growth. Through SLR rate tuning the money supply in the system can be controlled
efficiently.

The Indian banking sector is currently in a transition phase. While public sector banks are in the process
of restructuring, private sector banks are busy consolidating through mergers and acquisitions (the sector
has been recently opened up for foreign investments). With the Finance Minster’s announcement of
introducing a Bill on Banking Reforms, law on foreclosure and plans to set up an asset reconstruction
company (ARC), the sector is likely to witness a significant structural change the coming years.

The sector, which was considered dry in the last several years, has caught the investor fancy in
expectations of changing regulations and improving business conditions due to opening up of the
economy. Entry of private and foreign banks in the segment has provided healthy competition and is likely
to bring more operational efficiency into the sector. However, before investing in a banking stock an
investor should look at certain key performance ratios.

Unlike, any other manufacturing or service company, a bank’s accounts are presented in a different
manner (as per the banking regulation). The analysis of a bank’s accounts differs significantly from any
other company due to their structure and operating systems. Those key operating and financial ratios,
which one would normally evaluate before investing in company, may not hold true for a bank. We have
attempted to throw light on some of the key ratios, which are unique for banks and determine the financial
stability of a bank.

Before jumping to the ratio analysis, lets get some basic knowledge about the sector. The Banking
Regulation Act of India, 1949, governs the Indian banking industry. The banking system in India can
broadly be classified into public sector, private sector (old and new) and foreign banks.

 The government holds a majority stake in public sector banks. This segment comprises of SBI
and its subsidiaries, other nationalized banks and Regional Rural Banks (RRB). The public sector
banks comprise more than 70% of the total branches. 

 Old private sector banks have a largely regional focus and they are relatively smaller in size.
These banks existed prior to the promulgation of Banking Nationalization Act but were not
nationalized due to their smaller size and regional focus. 

 Private banks entered into the sector when the Banking Regulation Act was amended in 1993
permitting the entry of new private sector banks. Most of these banks are promoted by institutions
and their operating environment is comparable to foreign banks. 
  Foreign banks have confined their operations to mostly metropolitan cities, as the RBI restricted
their operations. However, off late, the RBI has granted approvals for expansions as well as entry
of new foreign banks in order to liberalize the system.

Now lets look at some of the key rations that determine a bank’s performance.

Ratios for evaluating operating performance

Net interest margin (NIM): For banks, interest expenses are their main costs (similar to
manufacturing cost for companies) and interest income is their main revenue source. The difference
between interest income and expense is known as net interest income. It is the income, which the
bank earns from its core business of lending. Net interest margin is the net interest income earned by
the bank on its average earning assets. These assets comprises of advances, investments, balance
with the RBI and money at call. 

NIM = Interest income – Interest expenses

------------------------------------
Average earning assets

Operating profit margins (OPM): Banks operating profit is calculated after deducting administrative
expenses, which mainly include salary cost and network expansion cost. Operating margins are
profits earned by the bank on its total interest income. For some private sector banks the ratio is
negative on account of their large IT and network expansion spending. 

OPM = Net interest income (NII) – operating expenses

-----------------------------------------------
Total interest income

Cost to income ratio: Controlling overheads are critical for enhancing the bank’s return on equity.
Branch rationalization and technology upgradation account for a major part of operating expenses for
new generation banks. Even though, these expenses result in higher cost to income ratio, in long
term they help the bank in improving its return on equity. The ratio is calculated as a proportion of
operating profit including non-interest income (fee based income). 

Cost to income ratio = Operating expenses

--------------------------
NII + non interest income

Other income to total income: Fee based income account for a major portion of the bank’s other
income. The bank generates higher fee income through innovative products and adapting the
technology for sustained service levels. This stream of revenues is not depended on the bank’s
capital adequacy and consequently, potential to generate the income is immense. The higher ratio
 indicates increasing proportion of fee-based income. The ratio is also influenced by gains on
government securities, which fluctuates depending on interest rate movement in the economy.

From the sample selected here, HDFC Bank tops the list with the best performance ratios. The bank’s
higher interest margins are on account of it’s lending to retail sector, which is considered to be high
margins business owing to low cost funds from retail deposits. SBI’s high cost to income ratio is on
account of its large employee base while ICICI Bank’s high cost to income is due to its aggressive
spending on expansion.

Other key financial ratios

Credit to deposit ratio (CD ratio): The ratio is indicative of the percentage of funds lent by the bank
out of the total amount raised through deposits. Higher ratio reflects ability of the bank to make
optimal use of the available resources. The point to note here is that loans given by bank would also
include its investments in debentures, bonds and commercial papers of the companies (these are
generally included as part of investments in the balance sheet). 

Capital adequacy ratio (CAR): A bank's capital ratio is the ratio of qualifying capital to risk adjusted
(or weighted) assets. The RBI has set the minimum capital adequacy ratio at 10% as on March 2002
for all banks. A ratio below the minimum indicates that the bank is not adequately capitalized to
expand its operations. The ratio ensures that the bank do not expand their business without having
adequate capital. 

CAR = Tier I capital + Tier II capital

---------------------------------

Risk weighted assets

NPA ratio: The net non-performing assets to loans (advances) ratio is used as a measure of the
overall quality of the bank’s loan book. Net NPAs are calculated by reducing cumulative balance of
provisions outstanding at a period end from gross NPAs. Higher ratio reflects rising bad quality of
loans. 

NPA ratio = Net non-performing assets

---------------------------

Loans given

Provision coverage ratio: The key relationship in analyzing asset quality of the bank is between the
cumulative provision balances of the bank as on a particular date to gross NPAs. It is a measure that
indicates the extent to which the bank has provided against the troubled part of its loan portfolio. A
 high ratio suggests that additional provisions to be made by the bank in the coming years would be
relatively low (if gross non-performing assets do not rise at a faster clip). 

Provision coverage ratio = Cumulative provisions

-----------------------

Gross NPAs

ROA: Returns on asset ratio is the net income (profits) generated by the bank on its total assets
(including fixed assets). The higher the proportion of average earnings assets, the better would be
the resulting returns on total assets. Similarly, ROE (returns on equity) indicates returns earned by
the bank on its total net worth. 

ROA = Net profits

---------------

Avg. total assets

n one of our recent articles, we discussed about some of the key ratios relating to a bank's balance sheet
statement. Just to brush up our readers, some of the ratios that were discussed included:

 Credit to deposit ratio

 Capital adequacy ratio
 Non-performing asset ratio
 Provision coverage ratio
 Return on assets ratio

We thought it would be an interesting idea to look and compare these numbers for the leading private
(HDFC Bank, ICICI Bank and Axis Bank) and public sector (SBI, Punjab National Bank and Bank of
Baroda) banks. In addition, we will also see how the same ratios have changed over the past few years.

Credit to deposit ratio: This ratio indicates how much of the advances lent by banks is done through
deposits. It is the proportion of loan-assets created by banks from the deposits received. The higher the
ratio, the higher the loan-assets created from deposits. Deposits would be in the form of current and
saving account as well as term deposits. The outcome of this ratio reflects the ability of the bank to make
optimal use of the available resources. 
 Source Data: Equitymaster research

If we see the following chart, ICICI Bank distinctly stands out from its peers. A strong reason for the same
would be its aggressive nature. Further, PSU banks and Axis Bank have seen their ratios increase
gradually over the years. The credit to deposit ratio of HDFC Bank on the other hand, has been fairly
stable.

Capital adequacy ratio: A bank's capital ratio is the ratio of qualifying capital to risk adjusted (or
weighted) assets. The RBI has set the minimum capital adequacy ratio at 9% for all banks. A ratio below
the minimum indicates that the bank is not adequately capitalized to expand its operations. The ratio
ensures that the bank do not expand their business without having adequate capital.

It must be noted that it would be difficult for an investor to calculate this ratio as banks do not disclose the
details required for calculating the denominator (risk weighted average) of this ratio in detail. As such,
banks provide their CAR from time to time.

Considering that the Indian banking sector has been growing at a strong pace, all the leading banks, both
private and public have been expanding operations at a strong pace. As such, their CAR ratios are well
above the prescribed limit of 9%. Private banks such as HDFC Bank, Axis Bank and ICICI Bank have in
fact increased their CAR over the past four to five years. 
 Source Data: Equitymaster research

As for the public banks, SBI and Punjab National Bank (PNB) have seen their CAR steadily expand over
the past few years as well. However, this ratio for Bank of Baroda has been fairly stable.

Non-performing asset ratio: The net NPA to loans (advances) ratio is used as a measure of the overall
quality of the bank’s loan book. An NPA are those assets for which interest is overdue for more than 90
days (or 3 months). Net NPAs are calculated by reducing cumulative balance of provisions outstanding at
a period end from gross NPAs. Higher ratio reflects rising bad quality of loans. 

Source Data: Equitymaster research

The NPA ratio is one of the most important ratios in the banking sector. It helps identify the quality of
assets that a bank possesses. If we look at the chart below, we can clearly see a differentiation between
India’s largest banks. A bank such as ICICI Bank would garner one of the highest NPA ratio amongst
private banks on the back of its aggressive nature. As the banks lends out strongly to customers, the
chances of them defaulting also rises. Plus, considering that private banks charge higher interest costs
would only make things more difficult for its customers. At the same time, the NPA ratio of a relatively
much conservative bank such as HDFC Bank would remain low. It is clearly evident from the above chart.
The marginal spurt in this ratio during FY09 is due to its acquisition of Centurion Bank of Punjab.
Further, Axis Bank has done well in the recent past to bring down its NPA ratio. So is the case for Bank of
Baroda (BoB). PNB has done well to keep its NPA levels low as well. As for India’s largest bank SBI, its
NPAs are relatively much higher than that of its PSU peers. This can also be attributed to its aggressive
period over the past few years.

Provision coverage ratio: The key relationship in analysing asset quality of the bank is between the
cumulative provision balances of the bank as on a particular date to gross NPAs. It is a measure that
indicates the extent to which the bank has provided against the troubled part of its loan portfolio. A high
ratio suggests that additional provisions to be made by the bank in the coming years would be relatively
low (if gross non-performing assets do not rise at a faster clip). 

Source Data: Equitymaster research

On observing the above chart, we can notice that private banks such as HDFC Bank & ICICI Bank as also
PNB and Bank of Baroda have been quite conservative when it comes to covering their NPAs. Axis Bank
on the other hand has been extra conservative in the past few years. This explains the reason for the
sharp improvement in the NPA ratio as well. The same can however, not be said about SBI, which is the
only large bank which has seen its provision coverage ratio deteriorate over the past four years.

Return on assets ratio: Returns on asset (ROA) ratio is the net income (profits) generated by the bank
on its total assets (including fixed assets). The higher the proportion of average earnings assets, the
better would be the resulting returns on total assets. 
 Source Data: Equitymaster research

While HDFC Bank has done well to maintain its ROAs over the past few years, that of ICIC Bank has
been gradually on a decline. The other banks, has however done well to improve their return ratio over
the past few years.

Conclusion

Looking at the above mentioned parameters, it would be quite easy to differentiate the aggressive banks
from the conservative ones. During good times and bad, banks such as HDFC Bank have managed to
keep things under control. Relatively aggressive banks such as ICICI Bank and SBI have been facing
some problems. Further, PNB, Axis Bank and Bank of Baroda have done well to improve their asset
quality, return ratios over the past few years as well.

It is recommended that you must not be prejudiced towards investing in stocks of only public or only
private sector banks. It is important to study various parameters related to financial statements of banks,
compare them to the peer group and also make sure that the stocks you pick meet your valuation criteria.