Money & Banking
How to analyse bank performance without the clutter

Higher net profit or net interest margin does matter, while analysing the financial performance of a bank. RBI may also consider mandating banks reporting total assets/ balance sheet size rather than the so-called 'total business' adding deposits, liabilities and loan assets to have a true and fair sense of banks' business growth

Come quarterly and annual bank financial results and investors and readers of business and financial newspapers are all agog over some analyst gushing 'Bank A’s net profit rises 35%, and some other analyst emoting ‘Bank B’s NIM is highest at 5 or 6 %' ! And all these are taken by readers and investors as holy grail suggesting that banks concerned have been exceptionally efficient and profitable! This need, and may, not at all be so. But before seeing why, it would only be instructive and value-adding to consider the business model of a typical competitive, efficient, safe, and sound bank.


A bank is typically characterised by relatively high financial leverage, which, in turn, is measured by what is known as Equity Multiplier (EM), which, in turn, is nothing but total assets of a bank divided by its common equity/ shareholder funds. Multiplying this leverage (EM) by what is called Return on Assets (ROA) gives Return on Equity (ROE) for a bank. Typically, competitive, efficient, safe and sound banks have had historically an average ROA of about 1% and a reasonably safe EM of about 15, implying an average market-competitive equilibrium ROE of about 15%.


In the recent period, the Indian Banking System has had leverage of about 13 to 14 times. Significantly, and hearteningly, to the credit of Reserve Bank of India (RBI) and the Indian banking sector, this corresponds to an average leverage ratio ( inverse of EM) of 7%+, which, at about 2.5 times, is way higher than 3% mandated by new Basel III capital rules to be complied with only in 2018 ! In other words, the Indian banking sector is already more than 2.5 times compliant on this critical Basel III parameter !!


In this context, another key financial parameter is what is known as Net Interest Margin (NIM), which is the difference between interest earned and interest expended as a percentage of a bank’s assets. Collectively for Indian Banks in the recent period, NIM has varied between 2.5% to 3%. If we deduct ROA from NIM, we get what can be called Non Interest cost of Intermediation. In fact, it is this critical parameter/ objective function viz (NIM-ROA) which, for a given ROA derived, in turn, from a given ROE and EM, it must be the dharma/ mantra of a role model bank management to minimize for maximizing returns to depositors and/ or minimizing costs to borrowers . Thus, either way, constrained minimization of the objective function (NIM-ROA) delivers value to all stakeholders viz, shareholders, insured and uninsured depositors, borrowers, taxpayers, in particular, and the real economy, in general.


To recapitulate, "the business model of a competitive, efficient, safe and sound bank is one which, while by minimizing the objective function (NIM-ROA) subject to the constraint of a given ROA, derived, in turn, from a given market-competitive equilibrium ROE, maximizes value for all stakeholders viz, depositors, borrowers, shareholders and public policy institutions, and allows it to grow sustainably by helping the real sector grow consistent with 'financial sector-real sector balance ' where the financial sector is ever a means to the real sector end !! "


Significance of NIM-ROA

We are now ready to unclutter the clutter in bank financial performance analysis and evaluation. As regards the myth of NIM being a key measure of profitability, let it be said that NIM by, and in, itself conveys nothing more than what it apparently does viz, as we have seen before, it is just the difference between interest earned, and interest expended, as a percentage of a bank’s assets. It is just a means to an end and not an end in itself ! For it, therefore, to make any sense, it needs to be analysed further beyond what it is by considering (NIM-ROA). For if NIM be 6%, and ROA be zero, then automatically ROE will also be zero and it is no brainer to see that this nominally very high NIM only establishes that the bank is neither competitive, efficient, safe nor sound ! Even if ROA be, say 2%, then ( NIM-ROA) will be (6%-2%) i.e. 4%. And this bank will be far less efficient and competitive than a bank whose NIM is, say 3%, and ROA , say 1% , and, therefore, (NIM-ROA) 2% ! This is because non-interest cost of intermediation of the higher- NIM bank is twice that of the lower- NIM bank and it is precisely this twice as large (NIM-ROA) and its reasons through its granular analysis and dissection that should engage the attention of bank analysts and investors!

For it is this (NIM-ROA) that subsumes all non- interest expenses such as taxes, salaries /wages /compensation, operational expenses, loan loss provisions, marked-to-market provisions, write-offs etc. And this (NIM-ROA) becomes even more significant, if the reported gross NPAs (non performing assets) are unusually low! Therefore, in the above example, the bank with lower (NIM-ROA) will be twice as efficient and competitive as the one with higher (NIM-ROA) because the former maximizes value for all stakeholders viz, depositors by way of higher deposit interest rates, borrowers by way of lower borrowing costs, shareholders by way of given ROA and market - competitive equilibrium ROE !


Higher net profit may not show real growth

Finally, coming to too much being made of, say 25% to 35% growth in net profits, this too needs to be regarded with circumspection for these numbers need to be adjusted for the growth in balance sheet / assets and not just considered in isolation and on a stand- alone basis. For if net profit grows at 35%, on a year-on-year ,or a CAGR, basis and assets/ balance sheet also grow by, say 35%, then there is really nothing to write home , or to feel gung-ho, about for the bank in question has been no more, and no less, efficient and profitable than before ! Another equally insightful way to see this is in terms of change in ROA. For example, if previous ROA be, say 1%, then there is no change in ROA as the ROA also remains unchanged at 1% for 35% growth both in net profits and assets/balance sheet ! On the other hand, if for a 35% growth in net profit, assets/ balance sheet grow by, say 25%, then the bank has been more efficient and profitable only to the extent of (1.35/1.25-1)*100 i.e.+ 8%, and not 35%, as bank analysts would unwittingly have readers and investors believe ! In this case, ROA increases fom 1% to 1*1.08 i.e 1.08% only ! Also, significantly, and equally, if assets/ balance sheet grow by 40%, then the so-called nominal profit growth of 35% will translate into a less efficient and less profitable performance of (1.35/1.40-1)*100 i.e - 3.5% and not 35% as ROA will decline to 0.96% from 1% previously although absolute net profit increased by 35% ! This then is the conceptually robust and technically rigorous nuts-and-bolts way of how bank analysts and investors must dissect bank financial performance and judge true and fair value of banking stocks for value investing/ buying!


Flaws in using deposits and loans as total business

While on the how-and-how-not of bank financial performance analysis and evaluation, a tail piece on banks' reporting of 'total business' will not be out of place and context. Typically, in India, it is routine for banks to report total business as the sum of deposits and loans to give analysts and investors a sense of growth in banks' business. But this is not only at variance with the international practice but also intellectually and conceptually flawed and vitiated for all 'business' is about generating revenues and returns for shareholders and it is 'total assets' that precisely do that and it is tautological and axiomatic that there is no way revenue generating assets can exist and grow without corresponding expense contributing liabilities! That is also precisely why, as sources and uses of funds, liabilities and assets appear opposite each other on a balance sheet. Significantly, the so called total business of banks has typically exceeded total assets/ balance sheet size by about 50%!


Therefore, while bank analysts and investors will do well to go that extra mile to have a true and fair sense of banks' business growth, with a view to aligning with the international practice, RBI may also consider mandating banks reporting total assets/ balance sheet size rather than the so called 'total business' adding deposit liabilities and loan assets.


(VK Sharma is former Executive Director of Reserve Bank of India)



sivaraman anant narayan

3 years ago

the article is very confusing. Could have been written in a more simple language so that the average reader can understand.

Gopalakrishnan T V

3 years ago

The article is highly technical,analytical and very useful for those who are interested in rating and serious investing. This type of analysis is valid and reliable provided the balance sheet and profit and loss account of banks is not window dressed.Here in India, the balance sheets and P&L accounts of banks do not reflect correct position is a well known secret and there is always a trade off between banks board, auditors and accountants. The NPAs are grossly underestimated by all possible means and the deposits and advances figures are inflated at year end by resorting to both ethical and unethical practices.NIM, ROA, ROE and any other yardstick derived from our banks' balance sheets and P&L accounts are cooked up figures and as such they are not dependable. Further, the way our Capittal market is functioning, the fundamentals of the listed companies and the economy are immaterial as the market is driven by speculation based on sentiments, political considerations and what not? The author's analysis may be possible at the Regulator's level as it has access to lot of inside information but its assessment is unfortunately not made known to public. However,all said, the author's attemp to throw light on the analysis needed is appreciable, though a lot of other variables can also be attempted to assess the strength of banks.

'Elections: An undocumented Wonder' by Dr SY Quraishi -Book Review

Former CEC Dr SY Quraishi unravels the myth and mystery behind the great election machine, the men and women who run the world’s largest democracy and the citizens who participate in it with great gusto in his book, 'An Undocumented Wonder'. The book will be launched in Mumbai on 9th May

The Indian election is a gigantic exercise that is often called the “greatest show on earth”, not merely because of the scale, size and diversity of the exercise but because of the vibrant volatility of our democracy.


Dr SY Quraishi’s well-written book “An undocumented Wonder- the Making of the Great Indian Election” would be launched in Mumbai ( ) on 9th May by Deepak Parekh, in presence of television and film actor Kabir Bedi and note social activist Medha Patkar, at the Indian Merchants Chamber.


Gopalkrishna Gandhi succinctly sums this up in his foreword to the book. He says, “India is valued the world over for a great many things, but for three over others: The Taj Mahal, Mahatma Gandhi and India’s electoral democracy. The credit for the last of the three fames goes to the people of India ... The people are the propulsive force, the driving energy of India’s Electoral democracy. ... But the vehicle’s engine, where ignition and combustion take place and the fuel and engine combine to move the vehicle is the Election Commission of India (ECI)”. And behind the vehicle’s steering wheel is the Chief Election Commissioner of India (CEC)”. Dr SY Quraishi, by documenting 'The Making of the Great Indian Election”, he says, has not only given us a ‘vivid portrayal of what makes India’s elections work and prevail over many obstacles that confront it’, but by also ‘confidence and pride’.


If only this well-written book had been released before the 2014 Parliamentary Elections instead of making its appearance at the fag end of the polls in May 2014, it would have made a world of difference, more particularly to the lakhs of people who were reportedly unable to vote in Pune, Nagpur and Mumbai. The Election Commission ought to have announced to citizens via print and electronic media that it expects everyone to recheck their names, even if they have been voting in all earlier elections. It would have made a big difference.


Dr Quraishi, in the chapter on Use of technology in the Indian elections outlines the Election Commission’s efforts at providing better services that include online enrolment in electoral rolls, complaint registration and public grievance management, call centres for public grievances, online information sharing and electoral roll search.


Dr Quraishi writes - “The book is my modest attempt to unravel the myth and mystery behind the great election machine, the men and women who run the world’s largest democracy and the citizens who participate in it with great gusto.


As promised, the pages are 'replete with anecdotes, case studies and analyses’. It ends with the author's reflections on ‘a few unresolved issues that affect Indian polity’ such as the paradox of great elections and a flawed democracy, election as the mother of corruption, the rise of the rich in politics, participation without representation, protest and participatory politics, the election as a festival and not a funeral’. Dr Quraishi also dwells at length on his own innovations, including the creation of Voters’ Education and Election Expenditure Monitoring Divisions, India International Institute of Democracy and Election Management and distribution of voter slips and their impact. Here again, as a Mumbaikar, I believe, if the distribution of voter slips was known to more voters through a public information campaign, they would have checked out to ascertain their names figure in the voting list and would not have had to return disappointed.


The book is divided into thirteen chapters – the most interesting reads are Engaging Youth: Converting Subjects into Citizens, Secure Elections Safer Democracy, Voter Education towards peoples’ participation, and Money power in elections.


The most illuminative to me is an extract on Election rules and processes in early medieval India (sourced from listing inter alia the selection process in ancient India. The nominee’s name written on a pre-designed palm leaf is dropped in the common pot (kodavolai in Tamil) on election day, in the presence of all the people. The oldest priest randomly transfers some leaves to another pot and a small boy from the crowd is asked to pick one. The winner is chosen. The basic criteria for contesting is that the candidate lives in a house on taxpaid land, is between the age of 35 and 70, knows the rules and laws mantra-prahmaana. The qualifications required are– knowledge of business, honest income, a pure mind and not been on any previous committees. The disqualifications are more stringent; they exclude those who are foolhardy, those who have accepted bribes in any form, have been on a committee that has not submitted accounts, the foolhardy, those who have stolen the property of another, partaken in forbidden dishes, committed sins and have become pure by performing expiatory ceremonies or those guilty of incest. For a country whose Bharatiya Sanskriti goes back millennia, some of these some of these qualifications and disqualifications probably need to be included in the Representation of Peoples Act, Election Moral Code of Conduct that are violated so brazenly.


Another interesting box lists the modus operandi of hiding illegal expenses during elections. The 40 different modes listed are unique, as also the six ways of corrupt political financing. There is a page on Financial Discipline and Accountability that requires audit of election expenditure by EC empanelled chartered accountants. These in-house auditors of political parties “are naturally likely to do a perfunctory or whitewash job” says the author.


Some over hyped controversies includes a box on How costly was the cost of covering Mayawati/ BSP symbol ‘elephant’. Dr Quraishi’s also has some interesting comments on his predecessors such as TN Seshan chomping carrots and gabbling on about how he eats politicians for breakfast, JM Lyngdoh being a stickler for rules, who moved Gujarat Chief Minister to refer to him in public rallies as ‘James Michael Lyngdoh in a sly reference to the fact that he is a Christian.’


The chapter Emerging concerns in Electoral Reforms delves with concerns of aam citizens like cleaning criminalization of politics, Tainted MPs in the Lok Sabha, Inner Party Democracy, Transparency in accounts of parties, the problem of dummy candidates, Right to Reject.


The pros and cons of the NOTA option that is used in France, Belgium, Brazil, Chile and Bangladesh, provisions regarding the Right to Reject in Canada are discussed at length. Compulsory Voting, relevance of First-past-the-post and Proportional Representation systems also figure.


The concluding chapter Reflections and afterthoughts has an interesting quote from Sir Winston Churchill –“Democracy is the worst form of government, except all those other forms that have been tried’ and failed.” This has his reflections on Trust in public institutions, Tally of the tainted, Enriching the rich, Mother of all corruption, Good Elections Flawed Democracy, Fifty plus one, his views on compulsory voting, Funereal or Festival, Yes, We Can, Is AAP Movement Democracy or Anarchy?


Overall, this book is a must read for all Indians to understand, from a man who has conducted this greatest show, what it means to participate in the election process. They will then see that being part of democratic India is not a right or a duty but a privilege and hopefully we will see even larger numbers of people coming out to vote in the future.

An Undocumented Wonder

Author: Dr SY Quraishi
Publisher: Rainlight Rupa,
434 pages
Price: Rs795 

(Nagesh Kini is a Mumbai-based chartered accountant turned concerned citizen activist.)


Economy & Nation Exclusive
Jignesh Shah arrested in Rs5,600 crore NSEL scam

The EOW of Mumbai Police arrested Financial Technologies' promoter Jignesh Shah in the Rs5,600 crore NSEL scam

The economic offences wing (EOW) of Mumbai police on Wednesday arrested Jignesh Shah, chairman and managing director of Financial Technologies (India) Ltd (FTIL) in the Rs5,600 crore National Spot Exchange Ltd (NSEL).


NSEL, promoted by Shah-led Financial Technologies group, is already being probed by various other regulators and investigative agencies with regard to a Rs5,600-crore payment default and persistent violations of various regulations.


Last year in September, EOW of Mumbai police searched 184 places across 16 states, including residences of Jignesh Shah, and Joseph Massey, the then managing director and chief executive of MCX-SX.


In December, commodities market regulator Forward Markets Commission (FMC), has termed Shah, FTIL and two other directors, Massey and Shreekant Javalgekar as 'unfit' to run Multi Commodity Exchange of India Ltd (MCX), the country's largest commodity exchange. The commodity market regulator also held FTIL and its directors, Shah, Joseph Massey and Shreekant Javalgekar responsible for Rs5,500 crore payment crisis at NSEL.


FMC had said, Shah was practically the 'highest beneficiary' of the fraud perpetrated at the NSEL Exchange. "It is because of the huge profit of Rs125 crore (approx.) earned by NSEL during FY 2012-13 that the value of the shares of Jignesh Shah in FTIL shot up manifold giving him the benefit of a spectacular market capitalization of his investment in FTIL running into thousands of crore of rupees. Jignesh Shah, as the promoter of FTIL and NSEL has misused his position to create a confidence in the minds of the participants regarding the legitimacy of the business and its operations in the exchange platform of NSEL. Shah consciously used his position to represent to the public at large about the attractive features of the contracts being traded on NSEL platform while taking no steps to introduce any effective governance mechanism including risk management, due diligence, assured collaterals etc., to ensure the legitimacy of his claims and to prevent frauds," the Commission had said in the order.


On 31 October 2013, Shah had resigned as non-executive vice-chairman of MCX after sector regulator FMC issued a notice to him and FTIL. MCX fiasco was due to the imposition of commodity transaction tax (CTT) applied in July and recent payment crisis at NSEL.


His statement issued at that time showed that he thinks he had lost control over the company forever. "The NSEL crisis has destroyed everything that I have worked hard to build over past two decades. My loss is not just financial but what has hurt me and my family most is the concerted effort to destroy my credibility and trust for which I have lived by all my life," he had said.


Here are notable facts about the mismanagement and poor governance of NSEL mentioned by FMC…

i. NSEL conducted its business not in accordance with the conditions stipulated in the notification dated 5 June 2007 granting it exemption from the operation of FCRA, 1952, with regard to the one-day forward contracts to be traded on its exchange platform. As noted in the show cause notice (SCN), the condition of ‘no short-sell’ and ‘compulsory delivery of outstanding position at the end of the day’ stipulated in the notification were violated by NSEL.

ii. NSEL Board allowed launching of paired back-to-back contracts on its exchange platform comprising a short-term buy contract (T+2 settlement) and a long-term sell contract (T+25 settlement) with pre-determined price and profit for the buyer and seller, which violated the very concept of spot market of commodities and the transactions ultimately were in the nature of financial transactions.

iii. The Directorate of Marketing, Government of Maharashtra passed an order on 26 December 2012 suspending the private market licence issued to NSEL with directions to them to ensure transparency in the transactions on the electronic platform.

iv. NSEL suspended abruptly its trading in all the contracts (except e-Series contract) leaving thereby an outstanding default of Rs5,500 crore (approx.) from a group of 24 borrowers with poor credentials who owed the money to a large multitude of over 13,000 investors.

v. The management of NSEL provided inconsistent figures about the fund availability in Settlement Guarantee Fund which, from a stated position of Rs738.55 crore on 1 August 2013 came down to a figure of only Rs62 crore on 4 August 2013.

vi. Within a few weeks, 19 out of 24 borrowers were declared defaulters and the management had no risk management tools at their disposal to recover any money from them.

vii. The management of the NSEL formulated a Settlement Plan to pay to the investors through equated weekly disbursements of Rs174.72 crore for 30 weeks, but till date have not been able to meet the said target for any single week.

viii. The NSEL engaged a collateral management firm, named SGS to make a detailed assessment of the stock of commodities lying in their accredited warehouses. As mentioned at paragraph No.7.3 of the SCN, SGS has pointed out in their interim report that from their inspection of 16 warehouses, physical verification revealed that as against stock of Rs2,389.36 crore supposed to be lying in these warehouses as per the records, stock worth only Rs358 crore was found. Moreover, the inspecting firm was prevented from inspecting 22 warehouses despite the fact that they were engaged by NSEL for carrying out inspection on their own stock lying in their accredited warehouses. The survey conducted by the Income -tax Department on 23 May 2013 at ARK Imports Ltd, a member of NSEL, wherein gross discrepancies in the stock of raw wool was found, has also been set out at paragraph no.7.4 of the SCN.

ix. The Commission directed NSEL to engage a forensic auditor to inspect their books of accounts, records maintenance etc. Accordingly, NSEL engaged a forensic auditing firm, Grant Thornton who have submitted their report to NSEL. From the report of the forensic auditor and other information collected by the Commission in course of dealing with NSEL, various facts about lack of due diligence and control over warehouses, gross irregularities in risk management by allowing repeated defaulters to trade without margin money or collaterals, poor clearing and settlement system, mis-utilisation of margin utilisation account, financing of defaulters by NSEL, allowing related party like IBMA (a group company) to trade on the platform of NSEL and MCX etc., have come to the knowledge of the Commission which have been elaborately addressed at paragraph 6 to 8 of the SCN issued to FTIL and the other three directors.

x. The Board of NSEL failed to constitute 9 out of 10 committees mandated under the rules and bye-laws of the Company which included important Committees such as Vigilance Committee, the Clearing House Committee and the Trading Committee etc., as a result of which there was absolutely no oversight over the risk management system in place at NSEL.



Shirish Sadanand Shanbhag

3 years ago

Highly informative, painstackingly well documented storey by Moneylife Foundation, of the scandel at FTIL & NSEL by Jignesh Shah.

jaideep shirali

3 years ago

The NSEL story shows how easily and casually the Govt can look the other way, when something illegal is going on under its nose. An illegal building comes up, just behind the BMC HQ and in front of the Police Commissioner's office at Crawford Mkt, supposedly without either's knowledge. Benami multiple share applications through NSDL demat accounts, insider trading, the list goes on. In case of NSEL, the Govt, through its numerous agencies, said first that no specific agency regulated NSEL, FMC was later brought into the picture. Mr. Chidambaram behaved as if nothing had happened, maybe no minister had lost money in NSEL. NSEL will not be the last scam, provided regulators constitute persons who understand problems from the investor's or customer's point of view. Till that happens, the government will remain mute spectators to scams that come and go, nobody will be punished, because the Govt is only keen to save somebody who was sleeping on the job.


3 years ago

Jignesh Shah is a Great Magicean

Sanjay M Shah

3 years ago


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