Banking Simplified!

Banking is considered to be the pillars of any economy. It is essential to understand this sector to get a sense of the various industries, consumer sentiment,etc. I am in the process of understanding the minute things operating in this sector. Let me share whatever I have learned till now. What are the factors which affect CASA, NIMs, NPAs,etc..

CASA impact on NIMs

Banks pay 3.5% interest on savings account. In reality, the actual cost of savings account is less than this as banks pay interest on the minimum balance kept between 10th and the last day of the month. The average cost of savings account is less than 3% and overall the cost of demand deposits could be even less than 2%, depending on the combination of savings and current accounts (CASA) of a particular bank.

Treasury/Government Bonds

Prices and yields of bonds have an inverse relationship and firm yields could saddle banks with mark-to market losses on their government bonds portfolio. Most banks do mark-to market accounting, making provisions for losses or profits at the end of each quarter, based on the difference between bonds prices and purchase prices. In case of 10 year bonds, prices fall by 7 paise for every basis point rise in yields. For example, if yields rise 100bps above last quarter then banks will have to provide for a loss of Rs 7 for every Rs 100 invested. Currently, banks investments of upto 25% of deposits in govt. bonds are protected from booking depreciation in bond yields if the bonds are kept in the HTM portfolio. The other two portfolios of banks bond investment are “Available for sale” and “Held for trading”. Banks are allowed to shift their bonds to HTM category once a year.

Impact of Ratings on Capital Requirements

Under the current standardised methodology of risk weighting, Triple “AAA” to “AA-” rated assets need to be risk weighted at 20%. However, if the credit rating sink to “A”, the risk weighting increases to 50%.

Bulk/Wholesale deposits

Bulk deposits are deposits by the corporates of the amount of Rs 1cr or more. Banks usually issue Certificate of Deposits (CDs) to corporates for a period between 3-12 months. In a tight liquidity scenario or higher interest rates regime, bulk rates might be higher than retail deposit rates. Rates fall equally fast in a surplus liquidity scenario. It might be slightly above Govt. bonds yields.

Interest Cost to the bank

The cost of funds of most banks is between 6-6.5% (mix of term and demand deposits rates). The cost of funds goes up by 2.5% due to the establishment costs and maintenance of CRR and SLR costs. Thus, the total cost to the bank is between 8.5-9%. To maintain Net interest margin of 2.5-4%, banks have to lend at 11-13% to the borrowers.

NPA’s Management

Banks protect their assets from becoming a non-performing loan (NPL) by going through the Corporate Debt Restructuring (CDR) exercise. Restructuring typically involves rescheduling the principal repayment date or even reducing the interest rates to help revive the borrowers cash flows. Banks recover non-performing loans through one-time settlement and compromise schemes, Lok Adalats, Debt Recovery Tribunals (DRT) and SARFAESI Act in addition to their own internal recovery process. A bank is allowed to write-off gross NPAs to the tune of mark-to market gains in govt. securities.

Loan Asset Classification

Banks classify loans as standard assets, sub-standard assets, doubtful assets and loss assets. Except for the standard assets, banks have to make provisions for the rest as they are treated as NPAs. According to RBI, an NPA is defined as a loan or advance where interest or installments of principal amount remain overdue for a period of 90 days in respect of a term loan.

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