Indian banking system is currently undergoing a major churn in an attempt to resolve issues such as inefficiency, poor decision making, asset-liability mismatch, slow growth, lack of basic corporate governance standards, and potential for fraud. Recent case of crisis-hit PMC bank customers trying desperately to get back their money presented a scary scenario and it was a wakeup call for all stakeholders.
Are you worried that your bank could also have a similar fate? Well, we certainly don’t want you to get panicky, but still one should always be extra cautious about their money kept in savings account, fixed deposits, recurring deposit, etc. In India, bank deposit insurance has a maximum limit of Rs 1 lakh, which is quite less. If your bank becomes bankrupt and is liquidated, you will get back a maximum of only Rs 1 lakh.
To ensure that your money remains in safe hands, you can take a few minutes to scan the financial health of your bank. You don’t need to be a finance expert to do this, as basic health of a bank can be assessed with a few simple ratios and financial indicators. Let’s take a look at some of the most important indicators that can help ascertain the financial health of your bank.
Gross NPA Ratio: Short for Non-performing assets, NPAs denote loans that have not received any interest payment for last three months. Interest from loans is one of the primary sources of income for banks, so high NPAs will indicate that the bank’s assets are performing poorly. NPA of 10% and below is considered healthy. Currently, public sector banks such as State Bank of India (SBI), Canara Bank and Indian Bank have NPA ratio of less than 10%. Banks with NPA ratio of more than 20% are deemed vulnerable. Some banks with more than 20% NPA include UCO Bank, IDBI Bank, and Indian Overseas Bank.
Formula: (Gross NPA/Total Advances) X 100
Net NPA ratio: Banks calculate this ratio after writing off some of the NPAs. High net NPA means that the bank will have reduced earnings in the future.
Formula: (Net NPA/Total Advances) X 100.
Provisioning Coverage Ratio (PCR): Banks make provisions for NPAs to reduce their overall risk of exposure to bad loans. PCR ratio should ideally be above 70%. High PCR ratio will indicate that adequate provisions have been made for bad loans and there is limited risk.
Formula: (Total provisions made/Gross NPA) X 100.
Total Capital Adequacy Ratio (CAR): The ideal CAR ratio for Indian banks is 9%. Higher CAR ratio indicates that the bank is safe and can grow without diluting capital.
Formula: (Total capital/ Total risk weighted asset) X 100.
CAR ratio has two sub-types – Tier 1 CAR and Tier 2 CAR ratio. In Tier 1 CAR, capital includes products such as perpetual bonds, non-redeemable preference shares and equity capital plus reserve. In Tier 2 CAR, capital comprises products such as long dated bonds and redeemable preference shares.
Tier 1 CAR Formula: (Tier 1 capital/Total risk weighted assets) X 100
Tier 2 CAR Formula: (Tier 2 capital/ Total risk weighted assets) X 100
CASA Ratio: This ratio measures the bank’s ability to access cheap funds. Higher CASA ratio indicates that the bank’s cost of funds is less. As a result, its profit margin will be higher.
Formula: (Total current and savings accounts/ Total deposits) X 100.
Net interest margin (NIM): This measures the quality of a bank’s interest earning assets. Both low cost deposits and high lending rates can help achieve high NIM. A combination of high NIM and low NPA is considered healthy.
Formula: ((Interest received – interest paid)/ Average interest earning assets) X 100.
Non-Interest Income: This income works as a cushion for banks in case their interest income starts to fall. It’s good to have a high non-interest income ratio, as it indicates that the bank can effectively deal with situations where interest income falls.
Formula: (Non-interest Income/ Average total funds) X 100.
Return on Assets (ROA): This ratio measures a bank’s ability to effectively utilize its assets in a profitable manner.
Formula: (Profit after tax/ Average total assets) X 100.
In case you notice that your bank is not meeting these important requirements, you can consider taking out your money and putting it in another bank. Usually, scheduled commercial banks and top-rated private banks are safer in comparison to cooperative banks. When you take action in a proactive manner, you can effectively safeguard your savings and avoid a crisis like situation.