Credit to Deposit ratio

Meaning

• Credit means loans given out to borrowers by the banks.

Credits are assets of the Bank.
• Deposits are the amount received from customers as
deposits in the banks. Deposits are a liability to the bank.
• So, credit-deposit ratio broadly means the ratio of assets
and liabilities of the banks.
Credit to Deposit ratio

Meaning
• The credit-to-deposit (CTD) or loan-to-deposit ratio (LTD) is
used for measuring a bank’s liquidity by dividing the bank’s
total loans disbursed by the total deposits received.
• It indicates how much of a bank’s core funds are being
used for lending which is the main banking activity.
• CTD ratio helps in assessing a bank’s liquidity and indicates
its financial health.
• A higher ratio indicates that the loans disbursed are more
than the deposits and vice-versa.
Credit to Deposit ratio

Importance & Impact

• If the ratio is too low, banks may not be earning as much as
they should, and it also indicates that banks are not
mobilizing their resources fully.
• If the ratio is too high, it means that banks might not have
enough liquidity to cover any unforeseen fund
requirements, which may cause an asset-liability
mismatch.
• A very high ratio is considered alarming because, in
addition to indicating pressure on resources, it may also
hint at capital adequacy issues, forcing banks to raise more
capital.
Credit to Deposit ratio

Importance & Impact

• Ideally there is no range in which the ratio should be, but it

should be neither too high nor too low hence it should be
kept in a balanced range.
• This ratio is a measure of banks financial health. When the
interest rate increases, deposits grow at a faster pace than
loans because higher interest rates push investors to invest
more money.
• Conversely, when rates are lower, deposits reduces.
Credit to Deposit ratio

Importance & Impact

• This ratio conveys how much of each rupee of deposit is

going towards credit markets.
• A higher growth in credit deposit ratio suggests credit
growth is rising quickly, which could lead to excessive risks
and leveraging on the borrowers side.
• In case of banks, it could imply that there will be a rise in
NPAs when economic cycle reverses.
Credit to Deposit ratio

Importance & Impact

• This ratio serves as a useful measure to understand the systemic

risks in the economy.

• Credit -Deposit Ratio = Total bank credit

Aggregate Deposits
(Demand + Time Deposits)
Credit to Deposit ratio

Illustration

• A bank has total advances of ₹ 40,000 crores and total

deposits of ₹ 50,000 crores. Compute credit to deposit
ratio.
Capital adequacy ratio-

Meaning

• Capital Adequacy Ratio helps in measuring the financial

strength or the ability of the financial institutions in
meeting its obligations using its assets and capital and it is
calculated by dividing capital of the bank by its risk-
weighted assets.
• Capital adequacy ratio is a measure to find out the
proportion of banks capital, with respect to the total risk-
weighted assets of the bank.
Capital adequacy ratio-

Meaning

• The credit risk attached to the assets depends on the

entity the bank is lending loans to, for example, the risk
attached to a loan it is lending to the government is 0% but
the amount of loan lends to the individuals is very high in
percentage.
Capital adequacy ratio-

Meaning
• The ratio is represented in the form of a percentage,
generally higher percentage implies for safety.
• High CAR indicates the ability of the lending institution to
undertake additional business and high capacity to absorb
unexpected losses.
• A low ratio indicates that the bank does not have enough
capital for the risk associated with its assets and it can go
bust with any adverse crisis, something which happened
during the recession. Lower CAR indicates lower loss
absorption capabilities.
Capital adequacy ratio-

Meaning
• Regulators worldwide have introduced Basel 3 which
requires them to maintain higher capital with respect to
the risk in the books of the company, in order to protect
the financial systems from another major crisis.
• The Basel III norms stipulated a capital to risk weighted
assets of 8%. However, as per RBI norms, Indian scheduled
commercial banks are required to maintain a CAR of 9%
while Indian public sector banks are emphasized to
maintain a CAR of 12%.
Capital adequacy ratio-

Meaning

• The capital adequacy ratio is calculated by dividing a

bank's capital by its risk-weighted assets. The capital used
to calculate the capital adequacy ratio is divided into two
tiers.
 Capital adequacy ratio-

Tier 1 capital

• Tier 1 capital or core capital consists of equity capital,

ordinary share capital, intangible assets and audited
revenue reserves. Tier 1 capital is used to absorb losses
and does not require a bank to cease operations.
• Tier 1 capital is capital that is permanently and easily
available to cushion losses suffered by a bank without it
being required to stop operating. A good example of a
bank’s Tier 1 capital is its ordinary share capital.
 Capital adequacy ratio-

Tier 2 capital

• Tier 2 capital comprises unaudited retained earnings,

unaudited reserves and general loss reserves. This capital
absorbs losses in the event of a company winding up or
liquidating.
• It is used to absorb losses if a bank loses all its Tier 1
capital.
 Capital adequacy ratio-

Risk weighted assets

• Risk weighted assets are used to determine the minimum
amount of capital that must be held by banks and other
institutions to reduce the risk of insolvency.
• The capital requirement is based on a risk assessment for
each type of bank asset.

• For example, a loan that is secured by a letter of credit is

considered to be riskier and requires more capital than a
mortgage loan that is secured with collateral.
 Capital adequacy ratio-

Importance

• During the process of winding-up, funds belonging to

depositors are given a higher priority than the bank’s
capital, so depositors can only lose their savings if a bank
registers a loss exceeding the amount of capital it
possesses.
• Thus the higher the bank’s capital adequacy ratio, the
higher the degree of protection of depositor's assets.
Capital adequacy ratio-

Capital Adequacy Ratio of Best and Worst 5 banks

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 Capital adequacy ratio-

Computation

• For calculation of Capital Adequacy Ratio (CAR), we need

the numerator which is the tier 1 and tier 2 capital of the
bank. We also need the denominator which is the risk
associated with its assets, those risks weighted assets are
Credit risk-weighted assets, Market risk-weighted assets,
and Operational risk-weighted assets.
Capital adequacy ratio-

Computation

• Compute Capital Adequacy Ratio from the following

information
Non-Performing Assets

Meaning

• A bank’s business involves providing loans to the

borrowers. The borrowers could be a company, individual
or any organization.
• The loans that are issued by the banks are known as bank’s
assets because the banks earn interest on the loans.
• But there is always a possibility that borrowers may default
on the payment of interest as well as the principal amount.
Non-Performing Assets

RBI Guidelines
• As per guidelines issued by the RBI, banks classify an
account as NPA only if the interest due and charged on
that account is not serviced fully within 90 days from the
day it becomes payable.
• Suppose, a loan account of Rs. 1,00,000 @ 10% interest
rate p.a. is due for payment on 30th September. If the
payment is not made within 90 days starting 30th of
September, the account will be classified as Non-
performing Asset.
Non-Performing Assets

Classifications of NPAs

• Banks classify NPA’s into the following 3 categories based

on how long they remain non-performing.
• The three categories are –
• 1. Substandard Assets,
• 2. Doubtful Assets and
• 3. Loss Assets.
Non-Performing Assets

Classifications of NPAs

• Standard Assets are those assets whose payment is

received by due date.
• Gross NPA consists of Substandard Assets, Doubtful Assets
and Loss Assets.
Non-Performing Assets

Classifications of NPAs

• Substandard Assets– If a loan account remains NPA for a

period less than or equal to 12 months.
• Doubtful Assets– An asset is doubtful if it has remained in
the sub-standard category for 12 months.
• Loss Asset– A loan account is declared as loss asset when
the bank’s internal or external auditors declare it so or RBI
inspection declares it as one.
Non-Performing Assets

Formula for Non- performing assets ratio

Non-Performing Assets

NPA Provision as per RBI Guidelines

• For precautions and to meet unforeseen losses, banks are

required to make provisions as per RBI guidelines. RBI
issues guidelines on Income Recognition, Asset
Classification and Provisioning.
• Banks have to provide 25% provision for unsecured
substandard assets. In case of doubtful assets (NPA for 1
year and more) 100% provision is to be made for the
unsecured portion of doubtful assets and 25% for the
secured portion.
Non-Performing Assets

NPA Provision as per RBI Guidelines

• In case of doubtful assets of more than 1 year but upto 3

years,100% provision is to be made for the unsecured
portion and 40% for the secured portion.
• If the asset is doubtful for more than 3 years, 100%
provision is to be made for the entire asset. In case of Loss
Assets, 100% provision is made. After detailed calculations
for each and every account, banks arrive at Gross NPA.
Non-Performing Assets

NPA Provision as per RBI Guidelines

• However, sometimes certain factors like ECGC coverage,

insurance claims and various subsidy by govt in different
loans are admissible. So, from the gross amount, these
amounts and provisions provided are netted to arrive at
Net NPA.
Non-Performing Assets

NPA Provision as per RBI Guidelines

Non-Performing Assets

Impact of High NPAs on Banks

• Banks with higher NPAs effectively have lesser funds to
advance because of the higher provisioning that they have
to provide i.e. lesser funds on which they can potentially
earn interest income.
• Other negative impacts of high NPAs are that the higher
NPAs will increase the amount of provisioning thereby
impacting the profitability of the banks.
• Thus Banks will face difficulty maintaining capital adequacy
ratio.
• There will be increased pressure on Net Interest Margin
(NIM) and compulsiveness to reduce high NPA’s.
Provision Coverage ratio

• To tackle the NPA or bad assets problem in the banking

sector, RBI has designed several mechanisms. An import
one among them is the Provisioning norms which is a part
of RBI’s prudential regulation
• Under provisioning, banks have to set aside or provide
funds to a prescribed percentage of their bad assets. The
percentage of bad asset that has to be ‘provided for’ is
called provisioning coverage ratio.
Provision Coverage ratio

• Provisioning Coverage Ratio (PCR) is essentially the ratio of

provisioning to gross non-performing assets and indicates
the extent of funds a bank has kept aside to cover loan
losses.
• Thus, provisioning coverage ratio is the percentage of bad
assets that the bank has to provide for (keep money) from
their own funds.
• Provision Coverage Ratio =
Provision Coverage ratio

• Provisioning Coverage Ratio (PCR) is essentially the ratio of

provisioning to gross non-performing assets and indicates
the extent of funds a bank has kept aside to cover loan
losses.
• Thus, provisioning coverage ratio is the percentage of bad
assets that the bank has to provide for (keep money) from
their own funds.
Provision Coverage ratio

• Provisioning should be made on the basis of the

classification of assets based on the period for which the
asset has remained non-performing and the availability of
security and the realisable value thereof.

• For example, if the provisioning coverage ratio is 70% for a

particular category of bad loans, banks have to set aside
funds equivalent to 70% those bad assets out of their
profits.
Provision Coverage ratio
Provision Coverage ratio

• A high PCR ratio (ideally above 70%) means most asset

quality issues have been taken care of and the bank is not
vulnerable.

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Net interest margin

• Net interest margin (NIM) is a measure of the difference

between the interest income generated by banks or other
financial institutions and the amount of interest paid out
to their lenders (for example, deposits), relative to the
amount of their (interest-earning) assets.
Net interest margin

• This metric helps prospective investors determine whether

or not to invest in a given financial services firm by
providing visibility into the profitability of their interest
income versus their interest expenses.
Net interest margin

• For example, say a bank made loans equal to ₹ 10 crore in

a year, which generated ₹ 55 lakhs in interest income. In
the same year, the bank paid ₹ 25 lakhs in interest to its
depositors.

• The bank's net interest margin can be calculated using the

following formula:

• net interest margin = (₹ 55 Lakhs- ₹ 25 Lakhs) / ₹ 10 crore

• = 0.03, or 3%.
Creditworthiness ratios

• 1. Profitability;

• 2. Capital Adequacy;

• 3. Assets Quality;

• 4. Efficiency;

• 5. Liquidity.
Creditworthiness ratios

• PROFITABILITY

• The ability of the bank to generate revenues capable of

covering costs.

• The institution has to register positive economic results.

• Negative results erode equity and, as a consequence,

reduce bank’s own resources.
Creditworthiness ratios

• Return On Asset (ROA) = Net Income (Loss)/Total Assets

• (how profitable are total assets)

• Return On Equity (ROE) = Net Income (Loss)/Equity

• (how profitable is equity)

• Interest Income on Loans = Interest Income on loans/Gross Loans

• (how are profitable gross loans).

Creditworthiness ratios

• CAPITAL ADEQUACY

• It analyzes the portion of total assets financed by own

resources. The higher the ratio the better the performance
of the bank.
Creditworthiness ratios

• The following ratios are explicitly considered and determined by the

Basel Committee and they are:

• Total Capital Ratio (Basel) = (Tier 1 Capital + Tier 2 Capital) / Risk

Weighted Assets

• Tier 1 Ratio (Basel) = Tier 1 capital / Risk Weighted Assets.

Creditworthiness ratios

• Tier 1 Ratio and TCR are evaluated considering the following

formula:

• Tier 1 Capital = Total equity - Revaluation reserves;

• Tier 2 Capital = Revaluation reserves + subordinated debt + Hybrid

capital + provisions including deferred tax + total loan loss and other
reserves
• In the Basel standards, Tier 1 Ratio has to be higher than 6% (that will be 8% until 2019)
and TCR higher than 8% (that will be 10.5% until 2019).
Creditworthiness ratios

• ASSET QUALITY

• The primary factor affecting overall asset quality is the

quality of the loan portfolio and the credit administration
program.

• Loans typically comprise a majority of a bank's assets and

carry the greatest amount of risk to their capital.
Creditworthiness ratios

• Asset quality ratio = Loan Impairment charges /Total assets,

• analyses the entity of the annual expenses for impaired loans respect the
total amount of asset.

• Loans quality ratio = Reserves for impaired loans/Gross loans

• in this case it is evaluated the weight of total doubtful loans on gross loans.
The reserve comprehends the total amount of impaired loans, cumulated
year after year.
Creditworthiness ratios

• LIQUIDITY

• Bank’s ability to meet its short term obligations.

• Short term Funding = Liquid Assets/Short Term Funding,

the bank has sufficient liquid resources to face short term debt, if
requested

• Loans Deposits = Loans/Deposits.

Creditworthiness ratios

• EFFICIENCY

• The last area we've considered is efficiency: it measures the

institution's ability to turn resources into revenues.

• Efficiency ratio = (Personnel expenses + Other operating

expenses)/(Net Interest Income + Total Non-Interest
Operating Income);
• The ratio gives investors a clear view of how efficiently the institution is
being run - the lower it is, the more profitable the bank will be.
Creditworthiness ratios
Performance evaluation measure using CAMELS rating system

• CAMELS is a method that is used to analyze performance

of the banks. It was generated by regulatory authorities in
United States in 1970s.

• The main purpose of this analysis is to control, supervise

and follow performance of the banks.

• In addition to this situation, this analysis also helps to

understand whether banks adopt related laws and
regulations and create an effective internal control system.
Performance evaluation measure using CAMELS rating system

• It is an off-side monitoring method that provides

mathematical evaluation for the banks regarding their risk
profile and the quality of the balance sheet.

• Hence, by using this analysis, it will be possible to define

any problems at an early stage
Performance evaluation measure using CAMELS rating system

• The six components in CAMELS analysis are

• Capital Adequacy (C );

• Asset Quality (A);

• Management Quality ( M);

• Earnings (E);

• Liquidity (L); and

• Sensitivity to Market Risk (S).

Performance evaluation measure using CAMELS rating system

• CAPITAL ADEQUACY

• It analyzes the portion of total assets financed by own

resources. The higher the ratio the better the performance
of the bank.
Performance evaluation measure using CAMELS rating system

• The following ratios are explicitly considered and determined by the

Basel Committee and they are:

• Total Capital Ratio (Basel) = (Tier 1 Capital + Tier 2 Capital) / Risk

Weighted Assets

• Tier 1 Ratio (Basel) = Tier 1 capital / Risk Weighted Assets.

Performance evaluation measure using CAMELS rating system

• Tier 1 Ratio and TCR are evaluated considering the following

formula:

• Tier 1 Capital = Total equity - Revaluation reserves;

• Tier 2 Capital = Revaluation reserves + subordinated debt + Hybrid

capital + provisions including deferred tax + total loan loss and other
reserves
• In the Basel standards, Tier 1 Ratio has to be higher than 6% (that will be 8% until 2019)
and TCR higher than 8% (that will be 10.5% until 2019).
Performance evaluation measure using CAMELS rating system

• ASSET QUALITY

• The primary factor affecting overall asset quality is the

quality of the loan portfolio and the credit administration
program.

• Loans typically comprise a majority of a bank's assets and

carry the greatest amount of risk to their capital.
Performance evaluation measure using CAMELS rating system

• Asset quality ratio = Loan Impairment charges /Total assets,

• analyses the entity of the annual expenses for impaired loans respect the
total amount of asset.

• Loans quality ratio = Reserves for impaired loans/Gross loans

• in this case it is evaluated the weight of total doubtful loans on gross loans.
The reserve comprehends the total amount of impaired loans, cumulated
year after year.
Performance evaluation measure using CAMELS rating system

• Management Efficiency

• Sound management is one of the most important factors

behind financial institutions performance. Indicators of
quality of management, however are primarily applicable
to individual institutions, and cannot be easily aggregated
across the sector.

• Furthermore, given the qualitative nature of management,

it is difficult to judge its soundness just by looking at
financial accounts of the banks.
Performance evaluation measure using CAMELS rating system

• Management Efficiency

• The credit-to-deposit (CTD) or loan-to-deposit ratio (LTD) is

used for measuring a bank’s liquidity by dividing the bank’s
total loans disbursed by the total deposits received.

• It indicates how much of a bank’s core funds are being used

for lending which is the main banking activity.

• A higher ratio indicates that the loans disbursed are more than
the deposits and vice-versa.
Performance evaluation measure using CAMELS rating system

• This ratio serves as a useful measure to understand the systemic

risks in the economy.

• Credit -Deposit Ratio = Total bank credit

Aggregate Deposits
(Demand + Time Deposits)
Performance evaluation measure using CAMELS rating system

• Management Efficiency

• Profit per employee:

• This ratio shows the surplus earned per employee. It is arrived at
by dividing profit after tax earned by the bank by the total
number of employees. The higher the ratio shows good
efficiency of the management.
Performance evaluation measure using CAMELS rating system

• Earnings Ability

• The following ratios are calculated:

• a) Dividend pay-out ratio

• b) Return on assets

• c) Operating profit by Average working fund

• d) Net profit to Average assets

• e) Interest Income to Total Income

Performance evaluation measure using CAMELS rating system

• Earnings Ability

• a) Dividend pay-out ratio:

• Dividend pay-out ratio shows the percentage of profit shared

with shareholders. The more the ratio will increase the
goodwill of the company.
Performance evaluation measure using CAMELS rating system

• Earnings Ability

• b) Return on assets:

• Net profit to total assets indicates the efficiency of the banks

in utilizing their assets in generating profits. A higher ratio
indicates the better indicates the better income generating
capacity of the assets and better efficiency of management in
future.
Performance evaluation measure using CAMELS rating system

• Earnings Ability

• c) Operating profit by Average working fund:

• This ratio indicates how much a bank can earn from its
operations out of the operating expenses for every rupee
spent on working funds. Average working fund are the total
resources employed by a bank.

• The higher the ratio, the better it is. This ratio determines the
operating profits generated out working capital employed.
Performance evaluation measure using CAMELS rating system

• Earnings Ability

• d) Net profit to Average assets:

• Net profit to average assets indicates the efficiency of the

banks in utilizing their assets in generating profits.

• It is arrived at by dividing the net profit by average assets,

which is the average of total assets in the current year and
previous year. Thus, this ratio measures the return on assets
employed. Higher ratio indicates better earnings potential in
the future.
Performance evaluation measure using CAMELS rating system

• Earnings Ability

• d) Net profit to Average assets:

• Net profit to average assets indicates the efficiency of the

banks in utilizing their assets in generating profits.

• It is arrived at by dividing the net profit by average assets,

which is the average of total assets in the current year and
previous year. Thus, this ratio measures the return on assets
employed. Higher ratio indicates better earnings potential in
the future.
Performance evaluation measure using CAMELS rating system

• e) Interest Income to Total Income:

• This ratio estimates the income gained from
lending operations as a percentage of the total
income earned by the bank during a financial year.
• Interest income is consists of interest/discount on
advances/bills, income on investments, interest on
balances with central bank and other inter-bank
funds.
• Total income consists of interest income and other
income like commission, net profit (loss) on sale of
investment, land and other assets, revaluation of
investment and miscellaneous income.
 Performance evaluation measure using CAMELS rating system

• The adverse effect of increased liquidity for financial

Institutions stated that although more liquid assets
enhances the ability to raise cash on short-notice, but also
reduce management’s ability to commit credibly to an
investment strategy that protects investors .
• Liquidity is another noteworthy aspect which expresses the
financial performance of banks. Liquidity means the ability
of the bank to honour its obligations toward depositors.
• Bank can preserve adequate liquidity position either by
increasing current liabilities or by converting its assets in to
cash quickly. It also denotes the fund available with bank to
meet its credit demand and cash flow requirements.
Performance evaluation measure using CAMELS rating system

• The following ratios is calculated:

• a) Liquid Assets to Total Assets
• b) Government securities to Total assets
• c) Approved securities to Total assets
• d) Liquid assets to Total deposits
Performance evaluation measure using CAMELS rating system

• a) Liquid Assets to Total Assets:

• This ratio expresses the overall liquidity
position of a bank. The liquid assets include
cash in hand, money at call and short notice,
balance with Reserve Bank of India and
balance with other financial institutions and
banks.
• Liquidity management is one of the most
imperative aspects of a bank. If available
funds are not properly utilized, the bank
may suffer loss because idle cash has no
return.
Performance evaluation measure using CAMELS rating system

• b) Government securities to Total assets:

• Government securities are the most liquid and
safe investments. This ratio measures the
government securities as a proportion of total
assets. Banks invest in government securities
primarily to meet their SLR requirements, which
are around 25% of net demand and time
liabilities. This ratio measure the risk involved in
the assets hand by a bank.
Performance evaluation measure using CAMELS rating system

• c) Approved securities to Total assets:

• Approved securities include securities other than
government securities. This ratio measures the
approved securities as a proportion of total assets.
• Banks invest in approved securities primarily after
meeting their SLR requirements. This ratio
measures the risk involved in the assets hand by a
bank.
Performance evaluation measure using CAMELS rating system

• d) Liquid assets to Total deposits:

• This ratio reveals the capability of a bank to fulfill
the demand from depositors during a particular
year. In order to maintain higher liquidity for
depositors, bank has to invest these funds in
highly liquid form so that the needs of the
depositors can be honoured in time.
Performance evaluation measure using CAMELS rating system
Performance evaluation measure using CAMELS rating system

• Sensitivity is expressed as the risk which occurs

due to alteration in market conditions, such
changes could adversely impact earnings and/or
capital.
• Market risk includes exposures associated with
changes in interest rates, foreign exchange
rates, commodity prices, equity prices, etc.
While all of these items are important, the
primary risk in most banks is interest rate risk.
Performance evaluation measure using CAMELS rating system

• The sensitivity of the market risk is assessed by

banks through changes in interest rate, foreign
exchange rates and equity prices. The changes
in these variables effects earning ability of the
bank.
• So, sensitivity to market risk expresses how
adversely the bank is affected due to such
changes. Market risk is the effect of trading
activities, non trading activities and foreign
exchange operation.
Performance evaluation measure using CAMELS rating system
Performance evaluation measure using CAMELS rating system

• Total securities to Total assets ratio:

• The higher value of this ratio is more risky means
the bank´s portfolio is subject to market risk.
Lower the ratio is good for the bank since it
expresses the appropriateness of response
towards market risk.
• This ratio reveals the correlation between banks’
securities and total assets. It also provides the
percentage change of its portfolio with respect to
alteration in interest rates or other issues
associated with the issuer of the securities. Total
Securities to Total Assets is calculated by diving
Total securities with Total assets.