Net interest margin (NIM)
For banks, interest expenses are their main costs (similar to manufacturing cost for companies) and interest income is their main revenue source. The difference between interest income and expense is known as net interest income. It is the income, which the bank earns from its core business of lending. Net interest margin is the net interest income earned by the bank on its average earning assets. These assets comprises of advances, investments, balance with the RBI and money at call.
Net interest margin (NIM) = (Interest Income – Interest Expense) / Average Earning Asset
Operating profit margins (OPM)
Banks operating profit is calculated after deducting administrative expenses, which mainly include salary cost and network expansion cost. Operating margins are profits earned by the bank on its total interest income. For some private sector banks the ratio is negative on account of their large IT and network expansion spending.
Operating profit margins (OPM) = [ Net interest margin (NII) – Operating Expenses ] / Total Interest Income
Cost to income ratio
Controlling overheads are critical for enhancing the bank’s return on equity. Branch rationalization and technology upgrade account for a major part of operating expenses for new generation banks. Even though, these expenses result in higher cost to income ratio, in long term they help the bank in improving its return on equity. The ratio is calculated as a proportion of operating profit including non-interest income (fee based income).
Cost to Income Ratio = Operating Expenses / (NII + Non Interest Income)
Other income to total income
Fee based income account for a major portion of the bank’s other income. The bank generates higher fee income through innovative products and adapting the technology for sustained service levels. This stream of revenues is not depended on the bank’s capital adequacy and consequently, potential to generate the income is immense. The higher ratio indicates increasing proportion of fee-based income. The ratio is also influenced by gains on government securities, which fluctuates depending on interest rate movement in the economy.
Credit to deposit ratio (CD ratio)
The ratio is indicative of the percentage of funds lent by the bank out of the total amount raised through deposits. Higher ratio reflects ability of the bank to make optimal use of the available resources. The point to note here is that loans given by bank would also include its investments in debentures, bonds and commercial papers of the companies (these are generally included as a part of investments in the balance sheet).
Capital adequacy ratio (CAR)
A bank’s capital ratio is the ratio of qualifying capital to risk adjusted (or weighted) assets. The RBI has set the minimum capital adequacy ratio at 10% as on March 2002 for all banks. A ratio below the minimum indicates that the bank is not adequately capitalized to expand its operations. The ratio ensures that the bank do not expand their business without having adequate capital.
Capital adequacy ratio (CAR) = (Tier I capital + Tier II Capital )/ Risk Weighted Asset
NPA ratio:
The ‘net non-performing assets to loans (advances) ratio’ is used as a measure of the overall quality of the bank’s loan book. Net NPAs are calculated by reducing cumulative balance of provisions outstanding at a period end from gross NPAs. Higher ratio reflects rising bad quality of loans.
NPA ratio = Net Non Performing Asset / Loans Given
Provision coverage ratio
The key relationship in analysing asset quality of the bank is between the cumulative provision balances of the bank as on a particular date to gross NPAs. It is a measure that indicates the extent to which the bank has provided against the troubled part of its loan portfolio. A high ratio suggests that additional provisions to be made by the bank in the coming years would be relatively low (if gross non-performing assets do not rise at a faster clip).
Provisions Coverage Ratio = (Cumulative Provisions) / Gross NPAS
The banking sector plays a very vital role in the working of the economy and it is very important that banks fulfil their roles with utmost integrity. Since banks deal with cash, there have been cases of mismanagement and greed in the global markets. And hence, investors need to check up on the quality of management.