Before diving into financial ratios, it’s important to understand the broader factors that influence the banking industry. Four key variables, controlled by the RBI, play a major role in determining liquidity, lending, and overall economic activity.
The Cash Reserve Ratio (CRR) refers to the portion of deposits banks must keep with the RBI. When CRR increases, banks have less money available to lend, reducing liquidity in the system.
Similarly, the Statutory Liquidity Ratio (SLR) requires banks to hold a certain percentage of deposits in liquid assets such as government securities, gold, or cash. A higher SLR further restricts lending capacity.
The Repo Rate is the rate at which banks borrow from the RBI. When it rises, borrowing becomes expensive, leading to reduced lending and slower economic activity.
On the other hand, the Reverse Repo Rate is the rate at which the RBI borrows from banks. When this increases, banks prefer parking money with the RBI instead of lending, again reducing liquidity.
Together, these four factors give a clear picture of the banking environment—whether liquidity is tight or abundant, and whether lending growth is likely to accelerate or slow down.
Key Parameters to Analyse in a Bank
Once you understand the macro environment, the next step is analysing a bank’s financials. Instead of getting overwhelmed, focus on a few key metrics that truly matter.
1. Interest Income: The Core Engine
Interest income is the primary source of revenue for any bank. It represents the money earned by lending funds to customers—whether through home loans, personal loans, or business loans.
A consistent rise in interest income usually indicates that the bank is expanding its loan book and generating higher earnings. For example, HDFC Bank reported a 19% year-on-year growth in interest income, reflecting strong lending activity.
For any investor, this is one of the first numbers to check in the Profit & Loss statement.
2. Net Interest Income (NII): The Real Earnings Power
Net Interest Income (NII) is the difference between interest earned and interest paid.
In simple terms, it shows how much a bank actually earns after paying depositors.
A rising NII indicates improving profitability, while a declining NII suggests pressure on margins. HDFC Bank, for instance, reported an 18% growth in NII—signaling strong improvement in its core business.
3. Net Interest Margin (NIM): Profitability Efficiency
NIM measures how efficiently a bank earns from its lending operations relative to its loan book.
A higher NIM means better profitability, while a declining NIM can signal margin pressure—even if loan growth remains strong.
For example, a slight drop in HDFC Bank’s NIM from 3.5% to 3.4% suggests moderation in lending profitability. While small, such trends are worth tracking over time.
4. Cost of Funds (CoF): The Hidden Driver of Margins
Cost of Funds represents the average rate at which a bank raises money.
Lower cost of funds is always better because it directly improves margins. A bank that can raise money cheaply—due to strong trust or brand—has a significant competitive advantage.
HDFC Bank’s declining cost of funds from 4.9% to 4.5% is a positive sign, indicating efficient funding management.
5. CASA Ratio: Cheap Money Advantage
CASA (Current Account Savings Account) ratio shows the proportion of low-cost deposits in total deposits.
Since current accounts pay zero interest and savings accounts pay very low interest, a higher CASA ratio reduces the cost of funds and boosts profitability.
However, CASA should always be analysed alongside NIM and CoF to ensure it is actually improving margins.
6. NPAs: The Reality Check
Non-Performing Assets (NPAs) represent loans where borrowers have defaulted.
Low NPAs indicate strong asset quality, while high NPAs signal risk and potential losses.
There are two key types:
- Gross NPA (GNPA): Total bad loans
- Net NPA (NNPA): Bad loans after provisions
HDFC Bank’s GNPA declining from 1.4% to 1.2% reflects strong credit discipline and recovery mechanisms.
7. Provision Coverage Ratio (PCR): The Safety Cushion
PCR measures how much of bad loans are already covered through provisions.
A higher PCR means the bank is well-prepared to absorb losses. Typically, a PCR between 65%–80% is considered healthy.
Think of PCR as a shock absorber—it protects the bank during stress periods.
8. Advances Growth: Business Expansion
Advances refer to loans given by the bank.
Strong growth in advances indicates business expansion and higher future earnings potential. However, this growth should always be compared with peers and checked for sustainability.
9. Capital Adequacy Ratio (CAR): Financial Strength
CAR measures how much capital a bank has relative to its risk-weighted assets.
It acts as a safety buffer during economic stress. In India, banks are required to maintain at least 9%, but strong banks often maintain much higher levels.
HDFC Bank’s CAR of 21.8% reflects a very strong capital position.
10. Credit to Deposit Ratio (CD Ratio): Lending Efficiency
The CD ratio shows how much of deposits are converted into loans.
A very high ratio (above 100%) can indicate aggressive lending and potential liquidity risk, while a very low ratio may indicate underutilisation of funds.
Balance is key.
11. Cost to Income Ratio: Operational Efficiency
This ratio tells us how much a bank spends to earn every ₹100 of income.
Lower is better. It indicates strong cost control and operational efficiency.
Final Thoughts
Analysing banks is not about looking at one or two numbers—it’s about understanding the complete picture.
Interest income, NII, and NIM tell you about earnings power.
CASA and cost of funds reveal efficiency in raising capital.
NPAs and PCR highlight risk management.
CAR and CD ratio show financial strength and liquidity.
When analysed together over multiple years, these metrics give a clear picture of a bank’s health.
The goal isn’t perfection—it’s understanding trends.
Because in banking, consistency matters far more than one good year.
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