Master Class 7: Analysis of Banking stocks and the importance of CASA Ratio, NPA, CAR

31 Aug 2020  Read 1304 Views

The banking and financial service industry forms the biggest chunk of the stock market index. They require a completely different skill set to differentiate between good and bad banking stocks. The analysis of banking stocks is quite different from the stock analysis of regular companies. This is because banks operate on a different business model as compared to other industries. This is why their financial statements are also prepared differently.

This is why the accounting methods and analysis of banks' financial statements need a completely different skillset and knowledge. Regarding this, the accounting ratios used for stock analysis are also very different from the regular accounting ratio.

Hence, we will take you through not all, but some of the most important accounting ratios that are required for the analysis of banking stocks. This article talks about the various important factors that are required for banking stock analysis and the future prospects of banking stocks. We will discuss concepts like CASA Ratio, NPA, Liability cost, CAR, and how they influence bank stocks as our choice for a potential investment.

Current Account and Savings Account (CASA) Ratio

In banks, deposits come from different sources such as current accounts, savings accounts, and term deposits, which form the major funding source for banks. Current Account and Savings Account (CASA) Ratio denotes how much of the total bank deposits is the money from the current accounts and savings accounts. 

In simple language, if the CASA ratio of a bank is 40%, it means that out of the total bank deposit of ₹100 the bank has received, ₹40 has come through deposits in current accounts and savings accounts.

The higher the CASA ratio, the better is the financial health of the bank. It is because deposits from current accounts and savings accounts are a cheap source of funding for the banks, as there is less interest that is paid on depositing money in these accounts. 

Bank pays an interest of Rs 0 on current accounts and ₹3-₹5 per ₹100 deposit in the savings account. From the banks' point of view, it spends much less to receive this money from you. Hence, the higher the bank's CASA ratio, the better the net interest margin, which suggests better operating efficiency of the bank.

A higher CASA ratio suggests better credibility for the bank as well.

CASA ratio is one of the most important factors to know if a bank is a good investment or not.

Net Non Performing Assets (NPA)

Non Performing Assets of NPA is a category of loans or advances that were given away by the bank in the past but are still in arrears or are yet to be paid. NPA is recorded in the bank's balance sheet after a prolonged period of non-payment by the borrower. Non-Performing Asset or the NPA, is the amount of money loaned to others that would never come back to the bank. 

Net NPA suggests the amount from the total loans given away by the bank, which has not been paid back by the borrower. Net NPA helps in determining how well a bank can differentiate between good borrowers and bad borrowers. A bad borrower will be someone who doesn't repay the loans he/she has taken.

Since banks' major business operation is to give out loans, it becomes important that it knows how to identify good borrowers and ensure that the loan money is returned. Hence, a good net NPA suggests the efficiency of the bank's operations.

Therefore, if Net NPA is 1% for a bank, it means for every ₹100 loaned by the bank, it is unable to get back ₹1. This is a loss for the bank.

A higher net NPA means the bank is inefficient in analyzing its lenders, and it is not a good sign. The lower the net NPA, the better the situation.

A lower net Net NPA suggests that a bank is efficient in analyzing its lenders and is able to receive its loan amount back. A lower net NPA is always a positive sign, and therefore, it is one of the most important factors in determining banking stocks.

Have you read our previous Master Class: Identifying the Bad Companies, Cash Flow Statement and Rights Issue

Cost of Liabilities

We have seen that the CASA ratio improves if the bank gets more current account and savings account deposits. However, if a bank starts offering a higher rate of interests on deposits, it can attract more deposits and can thus increase the CASA ratio. On the other hand, it will have to pay higher interest rates to the people.

The cost of liabilities represents the cumulative interest bank pays on its current deposits, savings deposits, fixed deposits, and others per ₹100 of the total deposits it receives. It is the average amount of interest that a bank has to pay to its depositors in current accounts, savings accounts, or term deposits.

While on the one hand, a higher CASA shows cheaper availability of deposits from customers; the cost of liabilities should also be low, so itis clear that the bank is not losing out its money by paying interests to its depositors.

Hence, to get a complete picture of the bank's financial health, one must look at both the CASA ratio and the cost of liabilities together.

Advances Growth

Advances growth or loan growth is a determinant of a bank's growth rate by telling the amount of loans a bank has distributed compared to the last financial year. This suggests how well a bank has grown from its past years. The Advances growth rate shows how much the bank has grown historically.

The higher the advance growth ratio, the faster the bank's growth.

Capital Adequacy Ratio (CAR)

Capital Adequacy Ratio is the amount of deposits a bank has with itself after giving out loans. Hence, it is the ratio of assets it holds against the loans it has given. A high Capital Adequacy Ratio (CAR) means that the bank still has enough capital, and hence its advances/loans can grow at a faster pace. It is understood that more lending means more profits for the bank.

While it is important that banks improve their advance growth, it is important that the Capital Adequacy Ratio (CAR) remains at least 12%, so that depositors' money is safe. The higher the CAR, the higher is the chance that it will lead to better advances growth. Usually, a bank with a high CAR will always have high advances growth as well.

CAR can be improved if the CASA ratio is high, and NPA is low. To ensure a high Capital Adequacy Ratio, a bank needs to bring in more capital, that is, the CASA ratio, and maintain a low net NPA.

Conclusion

The banking industry holds a major portion of the stock market. It is often a desirable choice among investors. It is crucial for investors to select banks that have healthy stocks, which can be done through an accurate analysis of CASA ratio, NPA, Liability cost, and CAR. 

Banks which have a low net NPA means that they have control over the NPA. A lowered NPA and high CASA Ratio ensure a good Capital Adequacy Ratio (CAR) and will eventually lead to a better advance growth as well. When ideal, all these things will eventually lead to an increase in the ROE, ROA, and EPS of the bank, thus increasing its financial performance.

These ratios can give a clearer insight into the bank's performance. To understand a more practical analysis of these figures, you can refer to YouTube for a video tutorial to guide you through real figures of real banks in the stock market.

Hop on to the next blog Series: 7 Things to look for in an Annual Report

To read all Master Class series Click Here

About the Author: Vivek Tiwari | 66 Post(s)

Vivek Tiwari is a Software Engineer and a Data Scientist who hopelessly fell for Economics. His plans to move to Finance might now save mankind from his IITJEE selection story.

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