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Doing a performance appraisal of banks, especially Indian ones, is not an easy task. What
are the factors that need to be considered to differentiate the good, the bad and the ugly.
If we just compare the major ratios for a financial analysis of banks, we may reach at
conclusions, which will be quite far from reality. Because these ratios do give a picture,
but not the complete one. This was very easily brought out in the global recession
recently, where a lot of reputed banks went under. Global behemoths collapsed under the
weight of their own inadequacies, which could not be properly reflected in their financial
analysis. However, there has to be some mechanism and parameters on which banks
could be compared and their performance measured. The traditional evaluation method
used the NPA (Non Performing Assets) level, the CD (credit deposit) ratio, the CAR
(Capital Adequacy Ratio) and other earnings ratios. In the new paradigm of banking,
these figures do not reflect all the reality. The business of banking and the banking of
business has undergone a sea change. This paper tries to put forth some other criteria on
which banks can be evaluated and their relevance to the new economic reality.


CASA (Current Account Savings Account)

NIM (Net Interest Margin)
CAR (Capital Adequacy Ratio)


The last few years have been a trying time for the global banking industry. India, and the
Indian Banking Sector, weathered this storm much better than their counterparts in the
more developed countries. This has also shaken up the banking industry, which now
realizes that it has to align itself to a new market reality, where the strategy which made
them big in the first place, will no longer be able to propel them further, and in fact may
contribute a lot to their downturn. India is not immune to these changes. The “Open Sky”
policy which was announced by RBI, and which was widely expected to be implemented
by 2009, in which foreign banks would be given a free run over the Indian countryside.
However, the global recession put paid to any such plans, and the MNCs’ were left
deciding how many people to rightsize and which business units to shut down and
discontinue. The Indian banking sector will see a lot of structural changes in the coming
years. Public sector banks realize they have to restructure to survive, private banks are
looking at newer avenues for growth and MNC banks are trying to grow post-recession.
There is no doubt that this will increase the level of competition and efficiency across the
industry spectrum.
Before trying to do a financial analysis of a bank, one needs to keep in mind that this
analysis will differ very much from the one for a company or firm. This is due to the
structure and operation structure of banks. There is no tangible product or measurable
service which they provide. For example, they do not bill by the hour or we cannot say
that they have sold these many units of a product in this year. However, there are certain
parameters, which will actually help in evaluating the true performance of a bank.


In the past, various studies with regard to the financial performance of banks have been
conducted. Swami studied the comparative performance of different bank groups. Das
has studied the correlation between the capital, non performing assets and the
productivity. Qamar has studied the profitability and efficiency of resource use. Uppal
has studied the efficiency, soundness and productivity. Mukherjee studied the benchmark
performance and technical efficiency.


Let us look at some key ratios that determine the performance of a bank:

1. CASA Ratio – (Current Account Deposits + Savings Account Deposits)/Total

This is important because this is an indicator of the profitability of the bank. CASA
consists of low cost deposits that the bank needs to service, whereas fixed deposits (or
term deposits) constitute high cost funds. The lower the cost of funds, the higher the
profit margins that a bank can make. It also has some bearing on the base rate/PLR
(Prime Lending Rate), the rate at which money is lent in the market.
The difficulty in maintaining a high CASA ratio is evident if we compare the same
for various banks in India. HDFC bank has the highest CASA ratio at around 55%.
AXIS Bank is next at around 40%. Thus we see that the even the best bank in this
regard, has only half of its funds from a low cost source.

2. NIM – Net Interest Margin – (Interest Income – Interest Expenses)/Average Asset

The main income for banks is interest income, that is, income from money lent out in
the market. The main expenditure for banks is interest expenditure, that is, the money
to be paid to the depositors who keep their money in the bank. The difference
between the two is the NII or Net Interest Income. This is the core revenue stream of
banks. As the definition of banking is collection of deposits from the public for
lending out of the same, it is clear that this should represent the major income stream
for any bank. The higher the difference, the better. For example, if a bank is able to
lend money in the market at 12 % and its cost of funds is 6%, it has a NII of 6%. This
is definitely preferable to a bank that may be lending at a higher rate of 14%, but the
cost of funds is also higher at 10%, leading to a NII of 4%. Again, HDFC Bank scores
in this aspect as they have a lower cost of funds.

3. Other Income to Total Income – fee based income is now a buzzword in the
banking industry. The reasons for it are not far to seek. This is net revenue to the
bank, whereas the other is merely notional income. Simply put, fee income is
money in the bank. It does not entail any major calculation, any capital
investment, or any NPA possibility. It simply leverages the network of the bank to
generate other revenue streams for the bank. However this is not a core business
of the bank. It represents cross sell of other products to the core client base of the
bank. Thus, this is also dependant on the core business of the bank. AXIS bank is
the leader in this aspect.

4. CAR (Capital Adequacy Ratio) – (Tier I Capital + Tier II Capital)/Risk Weighted


Tier I Capital – Core capital, including paid-up capital, statutory reserves and free
reserves including share premium and capital reserves arising out of surplus on sale
of assets.
Tier II Capital – this consists of undisclosed reserves, revaluation reserves, general
provision and subordinated debt.
This has become particularly important after the Basel norms have been put in effect.
Banks which have not been adequately capitalized would need to do so. This has
resulted in the Central Government capitalizing several public sector banks in the past
two years. Capital is important for branch and network expansion programmes, which
is not undertaken, may hamper the effectiveness of a bank.

5. RoA – Return on Assets – Net Profit/Average Assets

The other variant of this ratio is the RoE or Return on Equity. This gives the return
generated by the bank on its assets, including fixed assets.


We can say that it is better to evaluate banks on certain parameters which are more
objective in nature. Parameters like NPA levels are not very reliable nowadays,
because the ability of banks to choose what to show or what not to show as an NPA,
is very variable. This is also made possible by the book rule on NPA classification,
which enables banks to take advantage of the loopholes. It was this particular lacunae,
which led to underreporting of NPA levels in many banks, until it climbed to
unsustainable levels.

Das (2002), “Risk and productivity change of public sector banks”, EPW, Vol. 37,
No. 5, pp. 437-438
Qamar (2003), “Profitability and Resource use efficiency in scheduled commercial
banks in India”, Synthesis, Vol. 1, No. 1, pp. 1-16
Swamy (2001), “New competition, deregulation, and emerging changes in Indian
banking: An analysis of different bank groups”, Journal of the Indian Institute of
Bankers, Vol. 72, No.3, July – Sept, pp. 3-22
Uppal (2004), “A comparative study of business, efficiency, soundness, and
productivity of new private sector banks”, Journal of Indian Management Studies,
Vol. 8, No. 1, pp. 99-115