Arjun Singh Rathore
Every Business and every product has risks and you can’t get around it.
Lee Lacocca
Banking and financial institutions in India have been showing signs of trouble, it is no surprise. Many of them have come crashing down, creating a crisis-like situation for customers and investors. The perception that commercial banks will never be allowed to fail has led many depositors to invest their money in banks with the highest interest rates, paying little attention to their business or financials. But the recent episode with some private commercial banks as well with some cooperative banks remind us that even if the Reserve Bank of India (RBI) steps in to bail out a distressed commercial bank, the process is not pain-free for depositors. The bank’s fall is yet another reminder for customers to know better, such as not putting all their life’s savings in a single spot and keeping an eye out on the activities and performance of the institution unto which they entrust their hard-earned money.
In one such case of a leading commercial bank of South India with it’s pan India presence, RBI capped deposit withdrawals at Rs. 25000 for a 30-day period, while a merger is in the works. Even though the RBI stepped into the rescue of customers, customers themselves can track several warning signs that show that their bank is in trouble. Monitoring some basic operating metrics of a bank can give you a fair idea of its health. If you’re keen to avoid such episodes with your bank deposits in future, how do you spot the trouble signs in a Bank?
Financial Checks: Growth and profits in the banking business are fuelled mainly by leverage. For every Rs.100 of assets in a bank’s balance sheet, it may have just Rs.4 of its own capital, with deposits and borrowings making up the rest. This is what makes banks particularly fragile entities that can be tripped up by defaults, delay in loan repayments or funding constraints.
Four financial ratios can alert you early to brewing trouble. The first is the capital adequacy or capital to risk weighted assets (CRAR) ratio, which measures the amount of its own and supplementary capital held by a bank for every rupee of loans advanced by it.
A sub-set of this is the Tier I CRAR, which represents the bank’s permanent capital consisting of equity, reserves and other capital against which losses can be set off. Indian banks are required to maintain a minimum CRAR of 9 percent {11.5% including Capital Conservation Buffer (CCB)} and Tier I CRAR of 5.5 percent (8% including CCB from 1st October 2021). And Lakshmi Vilas Bank at the time of trouble in June 2020, had a CRAR of just 0.17 percent with a negative Tier I CRAR.
Then, there’s the quantum of doubtful loans in the bank’s books, as measured by its NPA (Non-performing asset) ratio. The gross NPA ratio measures the proportion of loans given out that are overdue for over 90 days.
The net NPA ratio measures bad loans after the bank has made provisions. Broadly, gross and net NPA ratios that are below 5 percent signal reasonable health, but trends in this ratio are more important to watch. A more than 0.5 percentage point quarterly jump in the NPA ratio suggests problems escalating.
Leverage ratio captures the extent of a bank’s Tier I capital to its total loans. The RBI allows banks to run with a ratio of 3.5-4 percent, but a ratio above 5 is a comfortable number.
To gauge if a bank has enough cash to meet its near-term dues, the Liquidity Coverage Ratio or LCR, is your guide. Measured as the high quality liquid assets held by the bank against its dues over the next 30 days, the higher this ratio is above 100 percent the better placed it is on liquidity.
These ratios are readily available for every scheduled commercial bank on a quarterly basis, in the document ‘Basel III Pillar 3’ disclosures on the bank’s website.
If RBI believes that a bank is walking a tightrope on indicators such as NPAs, CRAR or return on assets, it can immediately subject it to Prompt Corrective Action (PCA). During PCA, RBI can impose a variety of business restrictions on a bank, induct new management, replace Board members, or even merge it with another bank. Most PCA measures impact a bank’s financials and growth plans, until afresh capital infusion helps them pull out of PCA.
The Bank is like a highway, It’s an efficient and secured. It gets you to where you are going better. But the accidents are worse. So be careful and spot your Bank in time it can be shaky but not fragile.
(The author is Executive Manager & Branch Head at JK Bank Marble Market, Jammu)
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