How To Measure The Safety Of Your Bank?

A short video doing the rounds on the web on the purported strengths and weaknesses of various banks based on a particular ratio created a ruffle in investment circles, forcing even the Reserve Bank of India (RBI) to issue a clarification that the conclusion drawn from it was not right.

The parameter in question is the market capitalisation (Mcap) ratio, which is the total deposits/value of the company (bank) in the stock market. According to the video, if the Mcap ratio is less than 2.5, the bank is healthy. A comfortable Mcap ratio lies between 2.5 and 4. Anything above 4 is risky.

So, Kotak Bank, HDFC Bank, RBL Bank, ICICI Bank, Axis Bank, and IndusInd Bank are said to be ‘safe’, while Federal Bank, Karur Vysya Bank, Karnataka Bank, Dhanlaxmi Bank and South Indian Bank are in the ‘red zone’.

View from the top

BusinessLine spoke to the heads of some of these banks which were said to be unsafe as well as to some analysts on their perception of the matter, and the way forward.

Shyam Srinivasan, MD and CEO of Federal Bank, one of the banks listed in the red zone according to the video, said: “Given the overall stressed environment accentuated by the outcomes of the coronavirus, the video left customers worried. But they were not silly enough to believe it.”

Terming the issue “one more unfortunate virus”, Srinivasan said he did not want to make an issue of it, and was glad that despite the “noise” created by it, “our business has only grown over the last one week.”

In fact, in a testament to Federal Bank’s strength, it has committed ₹300 crore to YES Bank’s revival plan. Federal Bank will be issued shares at face value of ₹10 each.

VG Mathew, MD and CEO of South Indian Bank (SIB), another of the banks cited as not safe in the video, too, said that while they received more enquiries during the first two-three days after the incident, it petered off. Now there are no more queries. There was no impact on business, he added.

Pointing out the futility of the ratio in ascertaining the strength of banks, both Srinivasan and Mathew said the sharp fall and the equally sharp rebound of the market on Friday resulted in huge variation in this Mcap ratio. So, is it possible that the inherent strength of a bank can undergo such a huge change within a matter of hours, they wondered.

Also, the fact that the RBI has come out in defence of these banks has proved beyond doubt that no one need have any fears about their strength, Srinivasan said. Mathew concurred.

Maintaining CRAR

“CRAR (capital to risk assets ratio) is the major tool used across the world to assess the strength of banks,” said K Paul Thomas, MD and CEO, ESAF Small Finance Bank. “Banks in India maintain a high CRAR of about 14 per cent compared to the global standard of 8 per cent. Universal banks maintain 14 per cent CRAR and small finance banks more than 15 per cent. This shows the strength of India’s banks.”

The strength of a bank is demonstrated by multiple variables like market cap, capital adequacy, non-performing assets (NPA) performance and return on equity (RoE). These are the variables that matter the most, said Rajeev Yadav, MD & CEO of Bengaluru-headquartered Fincare Small Finance Bank.

“Banking is a business of trust/faith,” said Amnish Aggarwal, Head - Reaearch, Prabhudas Lilladher. “According to Basel III guidelines, banks have to maintain core tier-1 capital at 7.7 per cent. Thus, the amount of business done is usually 8-10x networth of any bank.

“Mcap is notional and if the price to book (P/B) is high, the Mcap is likely to be high and vice verse. So, by that yardstick, most PSU banks would be in the danger zone. But that is not the case in real life. PSU banks are backed by the government and are perceived to be safe, as the government will never default on public deposits.”

So then, is it right to use MCap to assess the strength of banks?

According to Fincare’s Yadav, the ratio in question (in the video) is “not relevant”. ESAF’s Thomas agrees. “This is not the right way to assess a bank,” he said.

Capital adequacy, feel good factor and confidence of investors are among the most important factors that go into weighing the strength of a bank, pointed out Prabhudas Lilladher’s Aggarwal.

Going forward

Going forward, while Srinivasan said that Federal Bank is fairly confident of “delivering on our guidance”, Mathew of SIB said this is an opportunity to engage more with the bank’s customers. “This will bring in more business,” he said.