For quite some time now, most senior bankers working for government-owned banks have been suffering from a fear psychosis. Now the paranoia has spilled over to depositors in many private banks although the triggers are different. The bankers are scared of sanctioning new loans for fear of being hounded by the investigative agencies if the loans turn bad while the depositors’ trust in banks is diminishing as some of them feel their money is not safe with banks.<\/p>\n
While welcoming a customer into their fold — both depositors as well as borrowers — banks follow the ritual of know your customer (KYC) to be sure where the money is coming from (in case of a depositor) and where the money is going (for a borrower). It\u2019s a rather tiresome process but no one can escape it. It\u2019s time bank customers, particularly depositors, knew their banks well.<\/p>\n
A bank collects money in the form of deposits and lends that money as credit and invests in bonds. Loosely speaking, the difference between the cost of funds and earnings from credit and other investments, net of operational cost, is a bank\u2019s profit.<\/p>\n
For every Rs100 deposit, a bank keeps Rs4 with the Reserve Bank of India (RBI) in the form of cash reserve ratio and invests at least Rs18.25 in government bonds (statutory liquidity ratio).\u00a0This money comes in handy for exigencies, such as sudden rush to withdraw deposits.\u00a0The rest of the deposits and capital are used to give loans, 40 per cent of which must flow into the so-called priority sector. Of course, a bank needs to keep enough liquid assets to cover its short-term liabilities.<\/p>\n
Banks can have the best of both worlds: When the interest rate rises, they make money on their loan portfolio; when the rate drops, money comes from investment in bonds. But this is in theory. The real world of banking is complex.<\/p>\n
How does one get to know one\u2019s bank? What are the parameters one should look for? The first and obvious thing to check is the profitability of a bank but that\u2019s not the only symptom of health. The quality of its assets is critical. It is gauged looking at the bad loans as a percentage of a bank\u2019s overall loan book. A loan turns bad when a borrower does not service it for three months. Bad loans are bad because banks do not earn any interest on such loans; on top of that, they need to provide for or set aside money for such loans. That hits their profitability.<\/p>\n
Even the best of banks can have\u00a0some bad loans in their portfolio. That\u2019s the nature of the business. Let\u2019s not get perturbed over this as long as a bank is running well and is adequately capitalised. Under the RBI norms, the current capital to risk-weighted assets ratio is 10.875 per cent which could go up to 11.5 per cent by March end. Different sets of loan assets carry different risks. Simply speaking, a bank needs to have Rs10.875 capital for every Rs100\u00a0<\/strong>risk-weighted assets. For small finance banks, the requirement is higher — Rs15.<\/p>\n Another important health indicator is the provision coverage ratio. Even for good assets, banks are required to make 0.40 per cent provision.<\/p>\n The higher the capital to risk-weighted assets and provision coverage ratio and the lower the bad loan ratio, the stronger the bank. None of these parameters should be seen in isolation. As long as a bank is adequately capitalised and profitable, one does not need to worry too much about its bad assets, unless the bank is hiding the pile.<\/p>\n Some of the public sector banks have been in losses and have\u00a0heaps of bad loans\u00a0but since the government is their majority owner, the depositors feel secure. The government takes care of these banks by pumping in capital periodically. The private\u00a0banks fend\u00a0<\/strong>for themselves. For the record, no scheduled commercial bank has been allowed to fail at least in the past three decades.<\/p>\n Every time a bank has been on the verge of collapse, the RBI has stepped in and worked out a rescue package to protect its depositors. This is, however, not the case with cooperative banks. Many of them have failed and their depositors have lost money.<\/p>\n All banks, including the cooperative banks, are required to buy insurance cover for their depositors\u2019 money. For each depositor, the cover is now for Rs5 lakh, inclusive of interest. This means even if a bank goes bust, the depositor is sure to get back at least Rs5 lakh. One can ensure a higher insurance cover by keeping money\u00a0through\u00a0different family members as depositors.<\/p>\n The investor\u2019s way of looking at a bank is different. If one wants to buy a bank stock, apart from capital and bad loans, one looks at ratios such as return on assets and return on equity besides the average cost of deposits and the business model.\u00a0One also looks at the price-to-book ratio which\u00a0compares a bank\u2019s market\u00a0value\u00a0to its\u00a0book value. The market\u00a0value\u00a0or market cap is arrived at by multiplying the price of the share\u00a0by the number of shares while the\u00a0book value\u00a0is its assets. India hosts some of the most valued banks in the world.<\/p>\n Finally, the quality of management and its corporate governance make one bank different from other. All these build trust, essential in the business of banking.<\/p>\n Once upon a time, banks used their fa\u00e7ade to inspire awe and trust among their customers. The magnificent structure of their headquarters made people believe their money was safe with their banks. That is why the Hong Kong and Shanghai Banking\u00a0Corporation\u00a0wanted to build \u201cthe best bank building in the world\u201d for its office in Hong Kong. Most bank headquarters in the developed markets are a must-see on every tourist\u2019s itinerary.<\/p>\n The grand fa\u00e7ade of the headquarters alone cannot create trust any more in the new age of banking. Let banks start displaying their key health indicators at their branches along with the RBI licence. The customers have the right to know their banks as much as the banks have their customers.<\/p>\n","protected":false},"excerpt":{"rendered":" For quite some time now, most senior bankers working for government-owned banks have been suffering from a fear psychosis. 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