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Key ratios related to banks' balance sheets

Mar 8, 2010

In the previous few articles of this series, we discussed the two key sections - the 'Capital and Liabilities' and 'Assets' - of a financial firm's balance sheet. Prior to that we discussed the 'Profit and loss statement' of a financial firm and some of the key ratios related to it. In this article, we shall discuss some of the key ratios related to a bank's balance sheet statement. While the article related to the key 'profit and loss statement' ratios was more to do with the performance of a bank, the following ratios are more to do with the financial stability of a bank. In addition, we shall also compare the following ratios of some of the largest Indian banks. Some of these key ratios are:

  • Credit to deposit ratio
  • Capital adequacy ratio
  • Non-performing asset ratio
  • Provision coverage ratio
  • Return on assets ratio

Credit to deposit ratio (CD 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.

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 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.

CAR = Tier I capital + Tier II capital / Risk weighted assets

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.

Tier I Capital funds include paid-up equity capital, statutory and capital reserves, and perpetual debt instruments eligible for inclusion in Tier I capital. Tier II capital is the secondary bank capital which includes items such as undisclosed reserves, general loss reserves, subordinated term debt, amongst others.

Non-performing asset (NPA) 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.

NPA ratio = Net non-performing assets / Loans given

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).

Provision coverage ratio = Cumulative provisions / Gross NPAs

Return on assets (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

Investing: Back to Basics Article Series - Previous article | Investing: Back to Basics Article Series


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5 Responses to "Key ratios related to banks' balance sheets"

Arup

Mar 30, 2019

i wish to learn the key ratios for identifying the potentialities lying with a stock for its selection purpose

Like (1)

Anjana M S

Jun 8, 2018

This article is very much helpful. It gives a detailed study and a brief Knowledge to measure bank's profitability position.. thank you very much...

Like (2)

Manav

Jan 5, 2017

It is an excellent article.i found it very informative and helpful and it is likely to help me in my research.

Like (6)

kavita desai

Mar 26, 2016

sir,
i want detailed information regarding ratios pls co operative me and send me details to given my mail id .

Like (5)

Anand

Jun 5, 2011

This series is very good. Especially for some one who is not an expert, a lot of examples have been very useful. Can you please include the next article link after this.

Like (2)
  
Equitymaster requests your view! Post a comment on "Key ratios related to banks' balance sheets". Click here!

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