If you wish to understand and analyze banking stocks, then, I would suggest you start learning the basics of banking first. Understanding a business should be the first step in investing into it. Therefore, understanding the bank operations could pave the way for you to invest in stocks and profit from them.
I have always believed ever since I came across the business of investing into stock markets that running your own business carries far higher risks than investing into one. You can easily jump out of a failing business unlike your own business. The companies listed on stock exchanges are in the public scrutiny and they adhere to the norms.
Banking business is one of the most lucrative businesses since it has come into conception. The earliest millionaires and the billionaires came through banking and investment firms. Banks also invest in the businesses of others. And apart from that they have many other ways to generate steady income.
So, if you are eyeing the banking stocks for investing, you can start with very basic understanding of these 7 parameters:
Loan book of a bank:
This is the first and the foremost parameter to look in. What is the size of loans the bank has? Banks lend to retail consumers like you and me, small and medium enterprises and big corporations. Banks also lend for foreign trade like letter of credit and bank guarantees. A well diversified loan across all the segments is a good loan book.
Some businesses are cyclical. Having a diversified loan book is good as the bank will continue to generate income and churn out profits even if one or two sectors of the economy fail to perform. So, here you should look for the size and the diversification in the loan book.
Deposit Growth(CASA):
Those who open bank accounts and park their money there are called depositors. And the funds that they park in their bank accounts is called deposit. Deposits are the cheapest source of money for a bank. The interest on savings is around 3% p.a. Current accounts don’t get any interest on the parked funds. On the other hand, banks charge much higher rates on their loan products. If the deposits of the bank are growing steadily under the Current Account and Savings Accounts category, then it is a positive sign for the bank and its stock buyer.
The simplest ratio to look at in their Annual reports is CASA ratio. CA means Current Account and SA means Savings Account.
Net Interest Income: (NII)
This is the bread and butter of a bank. Banks charge interest on their loan products to generate income. They give out interest on the public deposits (Current Account, Savings Accounts, FD, RD etc). The net of the income generated through the interest charged on loans and the expenses incurred on paying the interest on deposits is called Net Interest Income. Higher the interest income of the bank indicates that increased earnings for the bank.
NPAs or Non Performing Assets:
Those resources that generate income are called assets. I am sure you must have read this in a very popular personal finance book, Rich Dad, Poor Dad by Robert Kiyosaki. Therefore, banks call their loans their assets. When these assets of the banks stop generating income, they are classified as NPA or the non performing asset. The defaults on the bank’s balance sheet are negative.
Though, there are various regulatory norms to minimise the NPAs, but they can’t be zero. Lending is a risk taking business. What if the borrower did not return money, forget about the interest part ? And this applies equally to small retail depositors like you and me and the big corporations. Thus the NPAs should be on the lower side. And reduce over time.
Fee Income:
Apart from their lending activity, banks also perform various types of services to its various kinds of customers. These services are charged and the banks earn fee income by offering these services. Some such services are funds transfers, issuance of demand drafts and banker’s cheques, ATM services etc. Some banks even charge monthly/quarterly maintenance fees on savings and current accounts.
Commission Income:
Bank’s also sell the products like Small Savings Schemes of the government and act as their broker. The government pays the banks the commission on opening such accounts as PPF, Sukanya, SCSS etc. Apart from the government commission, banks sell mutual funds, insurance and demat accounts of their own subsidiaries or enter into tie up with other companies. These sales also generate a fair amount of income for the banks.
