How to Evaluate the Financial Stability of Banks Before Making an Investment

Gone are the days when people used to think of banks as a reliable keeper of their assets. In the post-liberalisation era, banks have taken recourse to aggressive loans, and these loans have invariably become non-performing assets (NPA), owing to a slacking worldwide economy. For this reason, we have been hearing of banking failures, leading to large-scale paranoia about the safety of deposited money. In this article, let us look at the factors that help banks build a system that does not collapse and how you, as a customer, can gauge the reliability of a bank before investing with them.

• The higher the GNPA, the worse the bank’s performance, making it unreliable for investment.
• High PCR, CAR, and CASA are green signals for you to invest in a bank.
• BVPS helps you understand the viability of your investment in stocks.

NPA refers to such loans given out by banks that do not generate any profit for them. According to current regulations, loans for which repayments have not been received for 90 days are to be marked as non-performing assets. Importantly, you can check a bank’s gross non-performing assets (GNPA) in their annual financial report.

It is not that banks do not predict loans turning out to be NPA. Rather, they preemptively set aside money, known as provisions, to offset the loss incurred due to NPA. To get the net NPA, you have to subtract the provisions from the GNPA. Therefore, if the GNPA of the bank was Rs. 3 crores and the provisions were Rs. 50 lakhs, then the net NPA would be Rs. 2.5 crores. To calculate the NPA percentage, divide the net NPA by the total loans and multiply by 100. An important point to understand from here is that the higher a bank’s GNPA, the worse the quality of its assets.

We have already talked about provisions that the bank keeps for its functioning. PCR is this provision expressed as a ratio. To calculate the PCR of a particular bank, divide NPA provisions by the total GNPA and multiply by a hundred, which will give you the PCR percentage. A high PCR is a sign that banks have safeguarded themselves against future losses owing to increased NPA. Typically, a PCR of 70% is considered to be good, and you may think about investing in banks that fulfil this criterion.

The CAR of a bank indicates its capacity to absorb or offset the losses that it has incurred owing to its NPA. In other words, this ratio gives you a fair suggestion about the percentage of the bank’s assets that are linked to its exposure to credit. Therefore, a high CAR is a green signal for you to invest in a particular bank. The Reserve Bank of India (RBI) sets and revises the required CAR for banks in accordance with the Basel norms. To give you an idea, if a bank has a CAR of 8-10%, it is considered to have an average ability to account for significant losses.

The CASA ratio is the funds across savings and current accounts divided by the total funds (deposits) that the bank has. A high CASA ratio indicates that the bank has more funds that produce cumulative high value for it, thus making it a safe entity to invest in. However, a low CASA ratio means that the bank relies on fewer funds of high value, thus making it a not-so-reliable investing option.

You can find out this ratio by dividing market capitalisation by book value. Book value is a subtraction of total liabilities from total assets, while market capitalisation is the multiplication of the market rate of the bank’s stock multiplied by the total number of stocks. A P/B ratio <1 means the stocks are undervalued, and >1 means the stocks are overvalued. These identifiers are not that great at helping you decide whether to invest or not. Instead, the book value per share (BVPS) helps you gauge whether the investment would be viable irrespective of the current market value of the stocks.