Learning to invest in stocks of banks will require a basic knowledge of some parameters which will help us know about the bank’s performance in financial terms. This will form the basis on which we can decide to invest in the stocks of one bank or the other. So, let’s start :
As discussed in our post on Business of Banking, there are two main facets of banking. To recap :
Banks lend money to customers and levy some interest on the loan. This is the Interest Income of the banks.
Banks give interest to customers who deposit amount in the banks as deposits or other accounts. This is the Interest Expense of the banks.
Net Interest Income :
It is calculated as Interest Income - Interest Expense
Net Interest Margin :
It is calculated as (Net Interest Income/Loan or Advance) * 100
Non-Performing Assets (NPA):
Banks give loan to earn interest on them. Some of these borrowers may not be able to service their loan and turn defaulters. Thus some percentage of the loans may turn out to not generate interest income as expected, for the banks. These loans are generally termed as Non-Performing Assets or Non-Performing Loans.Corporate Debt Restructuring (CDR):
If some companies are unable to payback the debt in the stipulated time, then they may request the banks for more time and also to show some leniency towards the conditions of the loan. The banks will then decide whether it is feasible to revisit the conditions of the loan. If they find that it is better to give the company some more time then they restructure the conditions for the repayment of loans like giving more time with additional oversight over the company’s expenditure etc. This is known as Corporate Debt Restructuring.CDR is a way for banks to provide support to their stressed assets and is done only for those loans which have the potential to come out of financial turbulence and generate income in future.Provisioning:
When the banks come to the conclusion that some of their loans are going to turn into NPAs they will set aside some amount from their profits to offset the effects of loan losses incurred due to NPAs. This is called Provisioning.Provisioning Coverage:
As per RBI regulations banks have to mandatorily set aside portion of their profits to provision for bad loans. This is called Provisioning Coverage.In a Nutshell:
Every bank wants that their borrowers should be able to clear their debt. No bank wants to enter into the hassles of NPA and CDR. If any bank is setting aside more amount towards this, then we investors need to be more cautious. However due to the nature of their business, banks may have to take NPAs in their stride. Control over their NPAs make the banks more cautious in respect of their quality of assets.Our modern economies invariably depend on banks and financial institutions for growth and expansion. Banks are thus an inevitable part of economic activity. Hence, Learning about banks and investing in stocks of banks also is that much important. This article will be a ready reference about banking fundamentals because the parameters on which banking is based is unique and their fundamentals behave differently than other industries. You can refer to More Banking Concepts for Investors to know about some more terms which may be useful in comparing banks.
