Worried after Yes Bank crisis? Know how healthy is your bank

“Are my bank deposits safe?” That’s the question many depositors have been asking after YES Bank — one of the fastest growing private sector banks — ran into trouble recently.

The RBI placed restrictions on the withdrawal of the bank’s deposits, causing hardship to small savers. While the central bank and government have laid down a revival plan for YES Bank, and will be lifting the moratorium on March 18, the episode has shaken the trust of depositors.

In fact, recently, reports of some banks failing to pass muster on a particular ratio (market capitalisation, or Mcap ratio) had set off panic among depositors. The Mcap ratio — defined as total deposits/market value of the bank — had purportedly breached a particular threshold for some banks, and had led to unwarranted anxiety among depositors. Banks and even the RBI had to step in to allay fears and bust the myth around the ratio.

So, is there a way to run a check on the health of your bank? Fortunately, there are several parameters and metrics that are available publicly, to help gauge whether your bank is headed for trouble. Of course, sometimes the financial statements do not reflect the actual state of affairs, in which case it may be difficult to detect a looming crisis beforehand.

Still, by keeping a tab on certain metrics you can assess the health of your bank.

Back to basics

Banks are in the business of lending and to do so they require funds. A bank’s balance sheet has capital — its own funds and borrowed funds — predominantly deposits on the liabilities side. On the assets side, a bank has loans as well as other assets such as cash and liquid assets — mainly government bonds.

Now, unlike other businesses, a chunk of a bank’s liabilities is funded by borrowed funds, essentially deposits. This is why a bank relies heavily on large amounts of deposits for its lending activity. It repays its deposits largely from money returned by its borrowers.

This is where the concept of bad loans and asset quality finds relevance.

Check for bad loans

Many of you may have often come across the words ‘NPAs’ and ‘stressed assets’. If you have dismissed these references as complex and only of use to bankers or analysts, it’s time to sit up and take note of them.

Technically, a bank classifies loans as non-performing assets (NPAs) when the borrowers have defaulted in their payments for 90 days or more. Simply put, an NPA is a loans where the borrower is unable to repay what he or she owes the bank. This can impair the bank’s ability to repay deposits in a stress scenario. Now, banks are required by the RBI to provide for such bad loans (buffer in case of future losses) by setting aside a portion of their earnings. Hence a sharp rise in NPAs can erode a bank’s profits.

Over the past three or four years, the sluggish economic environment has led to higher delinquencies or NPAs. Weak corporate governance in some cases and the RBI mandating banks to recognise certain accounts as NPAs have also led to a sharp rise in bad loans.

From about 4 per cent of loans in FY15, gross NPAs as a proportion of loans spiked to about 9 per cent in FY19, for all commercial banks put together, according to RBI data. Some banks have seen a sharper rise in bad loans than others.

But official NPA numbers alone do not fully reveal the extent of stress in a bank. Many banks also disclose SMA (special mention accounts where payments are overdue by 1-90 days). This helps to identify loans that could turn bad. Many banks also disclose their assessment of stressed book or ‘watchlist’ accounts — essentially lower rated corporate book — that could turn delinquent.

All of this can help you assess the overall asset quality of a bank. The higher the NPAs or stressed assets, the higher the risk of earnings and capital eroding.

Capital buffer

But don’t panic if your bank sports a high NPA figure alone. As mentioned above, in recent years, the broad slowdown in the economy and sudden crisis in certain companies and sectors have led to a rise in bad loans for many banks. What is important to note is whether your bank carries sufficient capital to absorb sudden losses on account of increase in bad loan provisioning.

Fortunately, regulatory norms around capital adequacy ratio (capital to risk weighted assets ratio, or CRAR) make it easy for you to assess a bank’s capital position. Currently, regulations require Indian banks to have a total CRAR of 10.875 per cent of their risk-weighted assets.

The CRAR is further divided into ‘Tier I’ and ‘Tier 2’. Tier I capital is the one that you need to closely monitor. This is because Tier I capital is always available to absorb losses, without the bank having to cease operations, as ‘going-concern capital’. Tier II, on the other hand, is supplementary capital. It absorbs losses only in the event of the bank winding up. As per Basel III norms, banks need to maintain Tier I capital of 8.875 per cent.

A combination of weak capital, large bad loans and low provision cover can be an early warning signal for depositors.

Liquidity check

Aside from looking at factors that can threaten a bank’s viability, it is also important to determine whether your bank can run into liquidity issues. This usually occurs due to an asset-liability mismatch (ALM) — a bank’s loans and deposits do not come up for payment at the same time.

But as a depositor, it may be difficult for you to gauge liquidity problems at a bank. Here again, some regulatory checks offer comfort.

From January 2015, banks are required to meet the guidelines on the minimum liquidity coverage ratio (LCR) set out by Basel III. The LCR requires that the stock of liquid assets be equal to 100 per cent of the total net cash outflows over 30 days. The main objective of LCR is to ensure that banks maintain sufficient liquid assets to meet obligations in a 30-day stress scenario.

In the case of YES Bank, the recently released third quarter results had revealed that the bank’s LCR had fallen to 74 per cent in the December quarter, and further to 20 per cent in March, owing to large withdrawals of deposits.

Hence keep a watch on the bank’s reported LCR vis-à-vis the mandated level. Every quarter banks put out Basel III disclosures separately on their websites, which give out capital ratios and LCR.

Remember that banks have several means to raise quick cash. Pre-emptive measures by the RBI such as cash reserve ratio (CRR) and statutory liquidity ratio (SLR) help banks to meet any shortfall. Banks have to set aside 4 per cent of their deposits in cash, which is parked with the RBI. SLR is the portion of deposits that banks need to hold in the form of government securities that can be easily sold to raise money. Currently banks have to hold 18.25 per cent of deposits as SLR.

Above all, it is important not to press the panic button on unverified reports circulated in social media. Always take well-informed decisions. Remember no bank can survive a ‘run’— where a large proportion of its depositors demand a refund at the same time.

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