You know how you wouldn’t judge a book by its cover, right? Well, the same goes for banks! I mean to say that banking stocks requires a different lens than other sectors due to their unique business model.
This Sunday, I decided to analyse key ratios to understand a bank’s financial health and potential. I found these are some of the most important ratios that we should compare before investing in any bank. Let’s grab our magnifying glasses, we might just uncover some hidden gems.
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1. CASA Ratio
Measures the bank’s dependence on cheap, stable sources of funds like checking and savings accounts. A higher ratio is better as it indicates a stable & cost-effective funding base (more trust from depositors).
2. Cost of Funds Ratio
Reflects how much a bank pays to borrow money. A lower ratio is better for higher profit margins.
3. Non-Performing Assets (NPA) Ratio
Indicates the percentage of a bank’s loans that are overdue and unlikely to be repaid. A lower ratio is better, it means less risk of defaults and higher profitability.
4. Loans/Advances Growth Ratio
Shows the year-on-year growth in a bank’s loan portfolio. Higher growth indicates business expansion but needs to be balanced with risk.
5. Capital Adequacy Ratio (CAR)
Measures a bank’s capital buffer to absorb potential losses. A higher ratio indicates a stronger financial position. Regulatory bodies set minimum CAR requirements. (Min. CAR requirements in India are set by RBI as follow: For Scheduled commercial banks (private banks) need a minimum CAR of 9% and for public sector banks must maintain a higher minimum CAR of 12%.)
6. Net Interest Margin (NIM) Ratio
Shows the profitability of a bank’s core lending business. A higher ratio indicates better profitability. Minimum ROA benchmark 1% and around 2% is considered good.
7. Return on Assets (ROA) Ratio
Measures how efficiently a bank generates profit from its assets. A higher ROA indicates better overall bank efficiency.
8. Price-to-Book Ratio (P/B Ratio)
Compares a bank’s stock price to its book value. A high P/B ratio might indicate future growth potential, while a low ratio could indicate undervaluation or risk.
By understanding these ratios, you can become a more informed investor in the banking sector.
Who is Winning based on the Above Parameters?
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