Safety First

health of your bank. Lisa Mary Thomson provides the pocketbook guide

    THIS is a typical nightmare sequence these days. You see an endless line of people spilling out of the bank, anxiously withdrawing their deposits and carrying money away in bags and suitcases. In a fit of worry, you join the line. But when you reach the front, the cash teller tells you they have stopped dispensing cash. In shock, you wake up, thankfully to realise that it was only a dream.
    There are numerous rumours that are going around about whether Bank A or Bank B is on a shaky ground. You're wondering if you're making the biggest mistake by not taking your money out. But before you take any hasty step, remember that you need to base your decision on something other than rumour. While this may be slightly tedious, SundayET tells you what you need to know to assess whether your bank is safe.
HEALTH BAROMETER
When it comes to assessing the health of a bank, it's important that you take both qualitative and quantitative aspects into account as weakness in one area could easily be compensated by strength in another segment. "Qualitative factors would include franchise, quality of underwriting, diversification of portfolio, exposure to sensitive segments, business risk profile, management, systems and the operating environment while quantitative factors are profitability, capital adequacy, asset liability mismatches (liquidity), asset quality, and size," says Vibha Batra, co head, financial sector ratings, ICRA.
LOOK UP AT THE RATINGS
There are a number of organisations within the country such as Crisil, ICRA and CARE, among others, which are involved with the process of rating institutions, including banks on multiple parameters. Different scales are created which depict credit quality keeping long-term, medium-term and short-term instruments in mind. For instance, in the ICRA long term rating scale, the highest rating LAAA would signify the lowest credit risk while the lowest rank LD would signal low prospect of recovery. The simplest option available for individuals is to check the rating of a specific financial institution with
these rating agencies, most of which is available on their websites. A scale explaining the ratings generally accompany the information.
    If your fear and curiosity cannot be satiated without research on your own part, then you could take some of the following ratios into account:
Non-Performing Asset Ratio The non-performing asset ratio shows the extent to which a bank's assets are unproductive. It is the ratio of all non-performing assets (where repayment of loans or interest is unpaid after 90 days of the specified time period) out of the loans disbursed and is hence an indicator of asset quality and the credit risk of the bank. "You could check both the gross NPA ratio and the net NPA ratio. However, the lower the ratio is, the better position your bank is in," says Batra.
Capital Adequacy Ratio
The capital adequacy ratio (CAR) of the bank is the ratio of its total capital (this includes tier 1 and tier 2 capital) to risk adjusted assets. This assures that banks will be able to withstand a certain degree of losses before becoming insolvent. As per the dictates of the RBI, the minimum CAR is 9%. "However, banks in India are generally well-capitalised. Moreover, if there are banks with a CAR of less than 12%, the government has assured that they will help them bring it up to at 12%," says Raman Oberoi, senior director, Crisil Ratings.
Liquidity Ratios
Moving on to liquidity ratios. "Statutory liquidity ratio (SLR) is a regulatory requirement in India and is applicable to all banks uniformly and present requirement is 25%. Hence, ratios like CD ratio (credit to deposit) and excess SLR (i.e. bank's holding of G-Sec above the regulatory requirement) are examined from liquidity perspective," says D R Dogra, deputy managing director, Credit Analysis & Research (CARE). The CD ratio is the ratio of the funds lent by the bank to the total amount raised via deposits." A higher ratio would indicate that there is more credit being given out. On an average, the CD ratio of banks in India was about 70-72%, as of March 2008," says Oberoi.
Operating Efficiency Ratios
When it comes to operating efficiency, it would pay to take a look at the net interest margin (NIM). This is the ratio of the net interest income (the difference of interest income and interest expenses of the bank) to the average earning assets. "A higher NIM is better" says Oberoi. You could also take a look at the cost to income ratio of the bank because this will reflect what the operating expenses are with relation to the total income. "The lower the cost to income ratio is, the better," says Batra.
TRUE OR FALSE
Many people have an impression that if the bank is bigger, the chances of its staying afloat are greater and to a great extent this is true. "Scale is an advantage to the bank as it gives them an edge in technology absorption and diversification benefits. Further, a larger size of capital enhances the loss absorption capacity. Big banks could lead to systemic risk and therefore may get greater support from the government in the event of stress," says Batra. But in terms of viewing share price as an indicator of stability, experts feel that this is often a false indicator and does not reflect the fundamentals of the bank. "However, share price or market capitalisation can be pointers to future capital raising ability of the bank," admits Dogra. Also, while banks guarantee up to Rs 1 lakh in case of a crisis affecting the bank, this is the total amount you will get irrespective of whether you have one or five accounts in the same bank.
    CHECK THIS
Non-performing asset ratio: The lower the NPA, the better
Capital adequacy ratio: The minimum CAR is 9%
Statutory liquidity ratio: Regulatory requirement is 25%
Credit to Deposit Ratio: Higher CD ratio reflect more credit being given out
Net interest margin: The higher the NIM, the better
Cost to income ratio: The lower the better