Is your bank on a short fuse?

“Are my deposits safe?” That’s the question many readers have been asking after Kolkata-based United Bank of India recently saw a spike in its bad loans, took a hit to its capital and suspended lending activities. With the domestic downturn stretching on and many banks faced with mounting bad loans, depositors are justifiably worried about the health of banks that house the bulk of their savings.

But thankfully, Indian banks which hold the lion’s share of public deposits are listed and they disclose their key financial parameters through quarterly and annual reports.

We decided to run a check on four critical financial parameters that determine the health of a bank and guide you on how to read them.

To start with the basics, a bank’s balance sheet has capital and deposits on the liabilities side, and loans given out and cash on the assets side.

Now, banks usually supplement their own equity funds with large amounts of deposits and borrowings. This is how they create a fund base large enough to lend out.

That’s why no bank can survive a ‘run’, a situation where a large proportion of its depositors demand a refund at the same time. A bank looks to repay its deposits largely from money returned by its borrowers.

In the normal course of business, a financially sound bank needs a comfortable buffer of capital to absorb losses.

That’s why regulatory efforts to strengthen banks usually start with the capital adequacy ratio.

Current regulations require Indian banks to have total capital amounting to 9 per cent of their risk-weighted assets — this is termed as CAR. But wait, what are risk-weighted assets?

RBI regulations link the amount of capital to the profile of its borrowers; riskier the borrowers, higher the capital needed. Different ‘risk weights’ are assigned to loans based on their possible default rates. For instance, loans to the Central Government have zero per cent risk weight while those to commercial real estate have 100 per cent weight.

The CAR is made up of Tier I capital, which is the bank’s own equity and Tier 2 capital which is funded by outsiders. According to Basel III norms, banks need to maintain Tier I capital of 6.5 per cent.

United Bank of India landed in trouble because escalating bad loans caused its Tier I capital to fall to 5.6 per cent, below the mandated level, thus prompting the central bank to curb further lending. While the minimum Tier I capital required is 6.5 per cent, the Government deems a bank comfortably placed if it has a CAR of 8 per cent.

Going by their financials for the quarter ended December 2013, Union Bank, Central Bank, UCO Bank, Dena Bank, IOB, Canara Bank, Bank of Maharashtra, Allahabad Bank and IDBI Bank are among those with CARs below the 8 per cent mark.

But a low CAR alone does not make a bank’s finances shaky. It matters whether the bank is adding to its capital or is seeing depletion in it due to bad loans.

This brings us to the second indicator to watch out for, which is asset quality. If a bank’s non-performing assets (NPAs) rise, it means loan repayments are not flowing in on time.

Rising NPAs require banks to set aside a partial provision towards them. In the case of United Bank, NPA provisions doubled in a single quarter as bad loans rose to 10.8 per cent in December, from 7.5 per cent a quarter ago. The bank made huge losses and the Tier I capital slipped 50 basis points to 5.6 per cent over a single quarter.

You would be glad to know that no other bank has gross non-performing assets (GNPAs) that are anywhere close to United Bank. In fact, GNPAs for all listed banks stood at 4.5 per cent by December 2013, with the number at 4.9 per cent for PSU banks.

But the real worry is that these official NPA numbers do not capture the extent of the bad loan problem, because banks carry large restructured loans too.

Restructured loans are those where the borrowers haven’t defaulted but have sought more lenient terms.

As these loans are accounted for as assets, if they actually turn bad, the bank’s assets would shrink. What depositors need to watch out for is the combination of a weak capital base with a rising proportion of stressed loans.

Taking stock of listed banks, we found that Union Bank, which has a Tier I CAR of 6.8 per cent, has GNPAs of 3.9 per cent and restructured assets of 6.4 per cent on its loan book. Effectively, 10.2 per cent of its existing loans are under stress. Central Bank, which has 7.1 per cent Tier I capital, similarly has 19.7 per cent of its loan book under a cloud.

Others such as UCO Bank, Dena Bank, IOB, Canara Bank, Bank of Maharashtra, Allahabad Bank, and IDBI Bank have problem accounts making up 10 to 15 per cent of their loan books.

Most private banks have managed to contain NPAs better than their state-owned counterparts, with GNPAs at 1 to 3 per cent and restructured loans averaging 1-2 per cent. While NPA provisions dent a bank’s capital, it is actual write-offs that can shrink it substantially.

This brings us to the third indicator — the extent to which a bank’s assets match its liabilities. A simple thumb rule to gauge this would be to total up the bank’s cash balances, investments and loans and check how they measure up against deposits and borrowings.

Here we assume, in the interests of being conservative, that NPAs are completely written off and that 30 per cent of restructured assets may go bad.

As of March 2013, United Bank’s loans, cash reserves and investments just about met the depositors’ and lenders’ dues. The bank’s adjusted assets stood at ₹1,08,000 crore while its liabilities were ₹1,06,000 crore. Contrast this with a healthy bank such as HDFC Bank, for which adjusted assets were 14 per cent higher than its liabilities.

Central Bank. UCO Bank, IOB and Dena Bank are some PSU banks whose March 2013 numbers show adjusted assets and liabilities running almost neck and neck.

Quite apart from factors which can threaten a bank’s viability, a bank can also run into liquidity issues. This usually occurs due to an asset-liability mismatch – a bank’s loans and deposits not coming up for payment at the same time.

To ensure that banks don’t fall short of hard cash in the ordinary course of business, the RBI requires them to set aside 4 per cent of their total deposits as cash reserve requirement (CRR) with it.

They also need to invest another 23 per cent of their total deposits in Government securities, which are highly liquid and can be easily sold to raise money.

RBI also has guidelines for asset-liability management which require banks to disclose their cash inflows versus outflows, over different time periods.

Sifting through bank financials for 2012-13, deposits which fall due in the up-to-one-year category for PSU banks were about 47 per cent, while only a third of their loans are set to be repaid within a year.

Some private banks with a mismatch were DCB, YES Bank, Kotak Bank, and IndusInd Bank. But banks that face liquidity mismatches in the short term do have means to raise quick cash.

They can borrow from the inter-bank market, bulk deposits or even pledge their excess SLR securities with the RBI. If you are still worried about the financial health of your bank, maybe it would help you to know that depositors have many safety nets to fall back on, in case of their bank landing in trouble.

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