FINANCIAL STATEMENT ANALYSIS FOR BANKING SECTOR

Credit to Deposit ratio (CD ratio):

• It denotes the value of loans given as a share of deposits held by banks. It is a

measure of how much a bank lends out of the deposits it has mobilized. It's
calculated by dividing a bank's total loans by its total deposits. The CD ratio
helps assess a bank's financial health. A low ratio can indicate that banks are
not making full use of their resources. A low ratio can also indicate excess
liquidity due to higher deposits and a lack of alternatives in credit markets. For
example, a CD ratio of 75% means that three-fourths of a bank's deposits have
been given out as loans. The RBI does not stipulate a minimum or maximum
level for the ratio.

CASA Ratio:

• CASA ratio stands for Current and Savings Account ratio. It is the ratio of
deposits in current and saving accounts to total deposits. CASA deposits are
cheap source of liquidity for banks as customers offer to keep their small
savings for a long term with the bank, which the lender subsequently uses for
growth and other operational purposes. A higher ratio means a larger portion of
a bank’s total deposits are in current and savings accounts, thus indicating,
lower cost of funds. Which means the higher the deposits in both accounts, the
lower will be the cost of managing the funds.

Capital Adequacy Ratio (CAR):

• It is a measure of a bank's capital in relation to its risk. It's also known as the
Capital to Risk (Weighted) Assets Ratio (CRAR). The CAR is reported as a
percentage of a bank's risk-weighted credit exposures. It's calculated by
dividing a bank's capital by its risk-weighted assets and current liabilities.

• CAR = (Tier 1 capital + Tier 2 capital)/Risk weighted assets

• It is an indicator of how well a bank can meet its obligations. The purpose of the
CAR is to ensure that banks have enough capital on reserve to handle a certain
amount of losses. The ratio compares capital to risk-weighted assets and is
watched by regulators to determine a bank's risk of failure.

Non-Performing Asset ratio:

• A nonperforming asset (NPA) refers to a classification for loans or advances that

are in default or in arrears. The non-performing asset (NPA) ratio is a
percentage that indicates how much of a bank's loans are in danger of not being
repaid. It's calculated by dividing the total gross non-performing assets by the
total assets. A high gross NPA ratio means the bank's asset quality is in very
poor condition. A loan becomes NPA if interest/EMI is not received for 3
 months. A lender may be required to categorize a loan as nonperforming to
meet regulatory requirements.

Provision Coverage Ratio (PCR):

• It is a metric that banks use to assess how well they are prepared to cover
losses from Non-Performing assets (NPAs). The PCR is calculated by dividing the
provisions made by the bank against potential loan losses by the total amount
of NPAs the bank has on its books. The PCR is the percentage of bad assets
that the bank has to provide for from their own funds. A high PCR can be
beneficial to banks to buffer themselves against losses if the NPAs start
increasing faster. The RBI prescribes an ideal PCR level of over 70 percent.

Return-on-Assets (ROA):

• It is a financial ratio that measures how profitable a bank is. It's calculated by
dividing a bank's net income by its total assets.

• ROA = Net income / Total assets.

• ROA indicates how efficiently a bank uses its assets to generate income. An
important point to note is since banks are highly leveraged, even a relatively low
ROA of 1 to 2% may represent substantial revenues and profit for a bank.

Return on equity (ROE):

• ROE is a measure of how efficiently shareholder capital is being used to

generate profit and is one of the most widely used metrics to assess banks'
profitability. ROE is calculated by dividing net income by total shareholders'
equity. A good ROE is usually considered to be 15% to 20%. A ratio of 5% would
be considered low. However, average ratios and what's considered "good" and
"bad" can vary substantially from sector to sector.

Net interest Margin:

• Net interest margin (NIM) is a profitability ratio for banks and other financial
institutions. It measures the difference between the interest income earned and
the interest paid by a bank or financial institution relative to its interest-
earning assets

• NIM = Net interest income/Earning assets

• NIM is calculated by comparing the net interest income a financial firm

generates from credit products like loans and mortgages, with the outgoing
interest it pays holders of savings accounts and certificates of deposits etc.
Cost-to-Income ratio (CIR):

• It is a measure of a bank's profitability. It's calculated by dividing the operating

expenses by the operating income. The CIR shows how much input (cost) the
bank requires to generate one unit of output (profit). In other words, CIR shows
the proportion of the bank's income that is being used to cover its operating
expenses. the lower a company's cost-to-income ratio, the better they're
performing. This indicates that the business is managing its expenses
appropriately and spending appropriately to create revenue growth. For most
industry sectors, 50% is the maximum acceptable ratio.

Loan-to-Assets Ratio:

• The Loan-to-Assets Ratio is a financial metric that helps assess a bank's risk
and the extent to which it has invested its assets in loans. It is calculated by
dividing the total amount of loans a bank has issued by its total assets. The
formula is as follows:

• Total Loans: This represents the sum of all loans that a bank has extended to
borrowers. It includes various types of loans such as mortgages, personal loans,
business loans, etc.
• Total Assets: This refers to all of the financial resources owned by the bank,
including loans, investments, cash, and other assets. It provides a snapshot of
the bank's overall size and the resources it has available.