Performance measurement of Banks -NPA analysis & credentials ofParametersOver the last few years Indian Banking, in its attempt to integrate itself with the globalbanking has been facing lots of hurdles in its way due to its inherent weaknesses, despite its highsounding claims and lofty achievements. In a developing country like ours, banking is seen as animportant instrument of development, while with the strenuous NPAs, banks have becomehelpless burden on the economy. Looking to the changing scenario at the world level, theproblem becomes more ironical because Indian banking, cannot afford to remain unresponsive tothe global requirements. The banks are, however, aware of the grim situation and are trying theirlevel best to reduce the NPAs ever since the regulatory authorities i.e., Reserve Bank of Indiaand the Government of India are seriously chasing up the issue. Banks are exposed to credit risk,liquidity risk, interest risk, market risk, operational risk and management/ownership risk. It is thecredit risk which stands out as the most dreaded one. Though often associated with lending,credit risk arises whenever a party enters into an obligation to make payment or deliver value tothe bank. The nature and extent of credit risk, therefore, depend on the quality of loan assets andsoundness of investments. Based on the income, expenditure, net interest income, NPAs andcapital adequacy one can comment on the profitability and the long run sustenance of the bank.Further, a comparative study on the performance of various banks can be done using a ratioanalysis of these parameters. There are a number of ratios that can be used to comment on thedifferent aspects:The essential ratios that can be used for assessing the banks profitability and sustenance areProfitabilityIntermediation Costs/Total AssetsAssetsNet Interest Income/Total AssetsOther Income/Total AssetsAsset QualityNPAs/Total AssetsNPAs/AdvancesStaff ProductivityNet Profit/ Total Number of EmployeeSustenanceCapital/RWAs
For commenting on the Banks performance, a comparison to the total assets of the bank willgive a true picture. Controlled ExpensesThe intermediation costs of a bank refer to the operating cost of the bank and include all theadministration and operational costs incurred while offering its services. The ratio of theintermediation costs of the bank to the total assets should be kept low to ensure greaterprofitability. As mentioned earlier, a technology savvy bank will always be in a better position toreduce its operating costs. Consider the operating expenses of the various banking sectors andthe industry average for the year 1999-2000. The costs for the entire SCBs rose by 9.1 percent.The maximum rise of 25.1 percent has been witnessed in the new private sector banks while theforeign banks experienced a decline in the operating costs by 3.3 percent. The ratio of theintermediation costs to the total assets indicates a decline. The maximum decline was in the caseof new private sector banks and the foreign banks. Margins - Lowered by Subdued Interest RatesThe ratio of the net interest income (Spread) to the total assets gives the net interest margin of thebank. This ratio is the actual measure of the banks performance as an intermediary, as itexamines the banks ability in mobilizing lower cost funds and investing them at a reasonablyhigher interest. By borrowing short and lending long, banks can earn higher spreads neverthelessby doing so they will be exposed to greater risks. Hence banks need to be cautious and shouldnot accept risks beyond their ability to control/manage them. Product innovation using the righttechnology is one approach, which can be followed by the banks to mobilize cheaper funds. Asset Quality - NPA burden loweringThe asset quality of the banks can be examined by considering the NPAs. These NPAs should beconsidered against not just total assets but also against the advances, cause the NPAs primarilyarise. When NPAs arise, banks have to make provision for the same as per the regulatoryprescriptions. When the provisions are adjusted against the Gross NPAs it gives rise to the netNPAs. Provisions reduce the risk exposure arising due to the NPAs to a reasonable extent as theyensure that the banks sustain the possible loss arising from these assets. Capital Adequacy Ratio-Strengthening FurtherThe one important parameter that essentially relates to the banks ability to sustain the losses dueto risk exposures is the banks capital. The intermediation activity exposes the bank to a varietyof risks. Cases of big banks collapsing due to their banks inability to sustain the risk exposures isreadily available. Considering this, it is highly essential to examine the capital vis-à-vis the riskweighted assets. This is the Capital to Risk Weighted Assets Ratio (CRAR) as given by the BasleCommittee. The statutory prescription for CRAR is 9 percent, which has been well surpassed bymost banks.
LIST of Ratios for Analysis of Performance of Banks 1. Profitability Ratios Interest Expenses/Total Income Non-Interest Expenses/Total Income Non-Interest Income/ Non-Interest Expenses Interest Income/ Total Assets Interest Expenses/ Total Assets Net Interest Margin (NIM) = NII/ Total Assets Profit Margin = Net Profit/ Total Income Asset Utilization = Total Income/Total Assets Equity Multiplier = Total Assets/ Equity Return on Assets = Net Profit/ Total Assets Return on Equity = Net Profit/ EquitySustenance: Capital to Risk Weighted Assets (CRAR) = Total Capital/ (RWAs) Core CRAR = Tier I Capital / RWAs Adjusted CRAR = (Total Capital - Net NPAs)/(RWAs - Net NPAs)Staff Productivity Net Total Income/ Number of Employees Profit per Employee = Net Profit/Number of Employees Business per Employee = (Advances + Deposits)/Number of Employees Break-even Volume of Incremental Cost per Employee = Cost per Employee/ NIM 1. Asset Quality Gross NPAs/ Gross Advances Gross NPAs/Total Assets Net NPAs/ Net Advances
Net NPAs/ Total Assets Provisions for loan losses/Gross Advances Incremental RWAs/ Incremental Total Assets 1. Total Assets Provisions for loans and investments/Total Assets(RWA = Risk Weighted Assets)Concepts used in the ratios are as follows:1. Cash in cash-deposit ratio includes cash in hand and balances with RBI.2. Investments in investment-deposit ratio represent total investments including investments in non-SLR Securities.3. Net interest margin is defined as the total interest earned less total interest paid.4. Intermediation cost is defined as total operating expenses.5. Wage bills is defined as payments to and provisions for employees (PPE).6. Operating profit is defined as total earnings less total expenses, excluding provisionsand Contingencies.7. Burden is defined as the total non-interest expenses less total non-interest income. Definitions of the ratios are as follows:1. Cash-Deposit ratio = (Cash in hand + Balances with RBI) / Deposits2. Ratio of secured advances to total advances = (Advances secured by tangible assets + AdvancesCovered by bank or Govt. guarantees) / Advances3. Ratio of interest income to total assets = Interest earned / Total assets4. Ratio of net interest margin to total assets = (Interest earned - Interest paid) / Total assets5. Ratio of non-interest income to total assets = other income / Total assets6. Ratio of intermediation cost to total assets = Operating expenses / Total assets7. Ratio of wage bill to intermediation costs (Operating Expenses) = PPE / Operating Expenses8. Ratio of wage bill to total expenses = PPE / Total expenses9. Ratio of wage bill to total income = PPE / Total income10. Ratio of burden to total assets = (Operating expenses - Other income) / Total assets.
11. Ratio of burden to interest income = (Operating expenses - Other income) / Interest income12. Ratio of operating profits to total assets = Operating profit / Total assets13. Return on assets = Net Profit / Total Assets14. Return on Equity = Net Profit / (Capital + Reserves and Surplus)15. Cost of Deposits = IPD / Deposits16. Cost of Borrowings = IPB / Borrowings17. Cost of Funds = (IPD + IPB) / (Deposits + Borrowings)18. Return on Advances = IEA / Advances19. Return on Investments = IEI / Investments20. Return on Advances adjusted to Cost of Funds = Return on Advances – Cost of Funds21. Return on Investment adjusted to Cost of Funds = Return on Investments – Cost of FundsOn the basis of these parameters try to compile a comparative assessment as under: 1. All Commercial Banks (or the Banking system) 2. Public Sector Banks 3. Old Private Sector Banks 4. New Private Sector Banks 5. Foreign BanksThis will indicate the comparative performance of your bank in relation to each group and the bankingsystem as a whole. But if one prepares the comparative statistics for the bank for the last three years, itwill also indicate the direction in which the bank is progressing.