TASK 18: A SMALL LEAK WILL SINK A GREAT SHIP Interest Income / Total Asset This ratio refers to the interest earned on the total assets used for this purpose to determine whether the rate is good, too high, or too low in order for the responsible management to decide whether to continue leaving these assets as is or use them differently. Normally the higher this ratio the better indicating the bank is earning a high interest rate or the proportion of interest earning assets (loans) to total assets is high or both of these effects. Too high of interest income to total assets ratio would be attributed to the high interest income (rate) derived from high risk loans (subject to default). Also, if the high interest income is being generated by too high a proportion of assets in loans that could stem from lack of liquidity. That is, the bank should have a reasonable amount of cash and cash like securities (easily converted to cash such as Treasury bills) as part of their total assets to meet withdrawal needs. If the interest income to total assets ratio is too low that usually is from earning low interest income (rate) and/or too little lending. Non -Interest Income / Total Asset Non-interest income is bank and creditor income derived primarily from fees including deposit and transaction fees, insufficient funds (NSF) fees, annual fees, monthly account service charges, inactivity fees, check and deposit slip fees, and so on. Credit card issuers also charge penalty fees, including late fees and overthe-limit fees. Institutions charge fees that generate non-interest income as a way of increasing revenue and ensuring liquidity in the event of increased default rates. Banks provide a number of other services in addition to lending and depositing money. For example, they provide credit and debit cards to their customers. For all the services offered, banks charge certain fees. Income earned through fees and other charges is called non-interest income. Operating Profit / Total Asset In accounting and finance, earnings before interest and taxes are a measure of a firm's profit that includes all incomes and expenses except interest expenses and income tax expenses. Return on Assets (ROA) is a type of return on investment (ROI) metric that measures the profitability of a business in relation to its total assets. This ratio indicates how well a company is performing by comparing the profit (net income) it's generating to the capital it's invested in assets. Operating profit is stated as a subtotal on a company's income statement after all general and administrative expenses, and before the line items for interest income and interest expense, as well as income taxes. Operating Expenses / Total Asset An operating expense, operating expenditure, operational expense, operational expenditure or opex is an ongoing cost for running a product, business, or system. Its counterpart, a capital expenditure, is the cost of developing or providing nonconsumable parts for the product or system. Operating expenses are incurred in the regular operations of business and include rent, equipment, inventory costs, marketing, payroll, insurance, and funds allocated for research and development. Operating expenses are necessary and mandatory for most businesses. Interest Expenses / Total Asset Interest expense relates to the cost of borrowing money. It is the price that a lender charges a borrower for the use of the lender's money. On the income statement, interest expense can represent the cost of borrowing money from banks, bond investors, and other sources. Interest expense is a non-operating expense shown on the income statement. It represents interest payable on any borrowings – bonds, loans, convertible debt or lines of credit. It is essentially calculated as the interest rate times the outstanding principal amount of the debt. The simplest way to calculate interest expense is to multiply a company's debt by the average interest rate on its debts. Interest expense can be both a liability and an asset. Prepaid interest is recorded as a current asset while interest that hasn't been paid yet is a current liability. Both these line items can be found on the balance sheet, which can be generated from your accounting software. A higher interest expense means that the company is paying more to its debtors. In general, a company's capital structure with a heavier debt focus will have higher interest expenses. HDFC Bank Ratios Interest Income/Total Assets (%) Non-Interest Income/Total Assets (%) Operating Profit/Total Assets (%) Operating Expenses/Total Assets (%) Interest Expenses/Total Assets (%) FY 2019-20 7.50 FY 2018-19 7.95 FY 2017-18 7.54 1.51 1.41 1.43 0.19 0.27 0.21 2.00 2.09 2.13 3.83 4.07 3.77 HDFC Bank 9 8 7 6 5 4 3 2 1 0 Interest Income/Total Non-Interest Operating Profit/Total Operating Interest Assets (%) Income/Total Assets Assets (%) Expenses/Total Assets Expenses/Total Assets (%) (%) (%) FY 2019-20 FY 2018-19 FY 2017-18 Federal Bank Ratios Interest Income/Total Assets (%) Non-Interest Income/Total Assets (%) Operating Profit/Total Assets (%) Operating Expenses/Total Assets (%) Interest Expenses/Total Assets (%) FY 2019-20 7.31 FY 2018-19 7.16 FY 2017-18 7.05 1.06 0.84 0.83 0.21 0.06 0.20 1.86 1.73 1.77 4.73 4.54 4.46 Federal Bank 8 7 6 5 4 3 2 1 0 Interest Income/Total Non-Interest Operating Profit/Total Operating Interest Assets (%) Income/Total Assets Assets (%) Expenses/Total Assets Expenses/Total Assets (%) (%) (%) FY 2019-20 FY 2018-19 FY 2017-18 Interpretation Interest Income / Total Asset This ratio refers to the interest earned on the total assets used for this purpose to determine whether the rate is good, too high, or too low in order for the responsible management to decide whether to continue leaving these assets as is or use them differently. As in case of HDFC the ratio is high compared to Federal Bank such as 7.50, 7.95, 7.54 (HDFC Bank) as of 7.31, 7.16, 7.05 (Federal Bank). But when we closely look towards the ratio the better performing is federal Bank as the ratio are increasing year after year. But HDFC is performing neither constantly nor increasing year after year. HDFC in 2017-18 was 7.54, but in 201819 it increased by 7.95 and later is came down to 7.50 least comparing the three years. Non -Interest Income / Total Asset As in case of HDFC the ratio is high compared to Federal Bank such as 1.51, 1.41, 1.43 (HDFC Bank) as of 1.06, 0.84, 0.83 (Federal Bank). But when we closely look towards the ratio the better performing is federal Bank as the ratio are increasing year after year. But HDFC is performing neither constantly nor increasing year after year. HDFC in 2017-18 was 1.43, but in 2018-19 it came down by 1.41 and later is increased to 1.51 comparing the three years. Federal Bank shows good improvement year after year. Operating Profit / Total Asset As in case of HDFC the ratio compared to Federal Bank such as 0.19, 0.27, 0.21 (HDFC Bank) as of 0.21, 0.06, 0.20 (Federal Bank). The ratio was high for HDFC in the year 2018-19 as 0.27 as well in case of Federal Bank it was in the year 2019-20 as 0.21. Operating Expenses / Total Asset As in case of HDFC the ratio compared to Federal Bank such as 2.00, 2.09, 2.13 (HDFC Bank) as of 1.86, 1.73, 1.77 (Federal Bank). Here we can see that the ratio is fall that shows the company has tried to reduce expenses over the three years as it shows that it is dropping down year after year. But in case of Federal Bank in 2017-18 it was 1.77 it has dropped to 1.73 in 2018-19 but later in 201920 it has further increased. Interest Expenses / Total Asset As in case of HDFC the ratio compared to Federal Bank such as 3.83, 4.07, 3.77 (HDFC Bank) as of 4.73, 4.54, 4.46 (Federal Bank). The ratio of HDFC shows that the bank has tried to reduce the interest paid as in was 3.77 in 2017-18 whereas it increased to 4.07, but later in comes down to 3.83 . But in case of Federal Bank it is increasing from 4.46 in 2017-18 to 4.54 and then to 4.73. This shows no good sign as ratio is increasing. HDFC has done better. CAMEL ANALYSIS CAMELS is a recognized international rating system that bank supervisory authorities use in order to rate financial institutions according to six factors represented by its acronym. Supervisory authorities assign each bank a score on a scale. A rating of one is considered the best, and a rating of five is considered the worst for each factor. CAMELS RATING SYSTEM Banks that are given an average score of less than two are considered to be highquality institutions. Banks with scores greater than three are considered to be lessthan-satisfactory institutions. The acronym CAMELS stands for the following factors that examiners use to rate bank institutions: Capital Adequacy Examiners assess institutions' capital adequacy through capital trend analysis. Examiners also check if institutions comply with regulations pertaining to riskbased net worth requirements. To get a high capital adequacy rating, institutions must also comply with interest and dividend rules and practices. Other factors involved in rating and assessing an institution's capital adequacy are its growth plans, economic environment, ability to control risk, and loan and investment concentrations. Asset Quality Asset quality covers an institutional loan's quality, which reflects the earnings of the institution. Assessing asset quality involves rating investment risk factors the bank may face and balance those factors against the bank's capital earnings. This shows the stability of the bank when faced with particular risks. Examiners also check how companies are affected by the fair market value of investments when mirrored with the bank's book value of investments. Lastly, asset quality is reflected by the efficiency of an institution's investment policies and practices. Management Management assessment determines whether an institution is able to properly react to financial stress. This component rating is reflected by the management's capability to point out, measure, look after and control risks of the institution's daily activities. It covers management's ability to ensure the safe operation of the institution as they comply with the necessary and applicable internal and external regulations. Earnings A bank's ability to produce earnings to be able to sustain its activities, expand, remain competitive are a key factor in rating its continued viability. Examiners determine this by assessing the bank's earnings, earnings' growth, stability, valuation allowances, net margins, net worth level, and the quality of the bank's existing assets. Liquidity To assess a bank's liquidity, examiners look at interest rate risk sensitivity, availability of assets that can easily be converted to cash, dependence on shortterm volatile financial resources and ALM technical competence. Sensitivity Sensitivity covers how particular risk exposures can affect institutions. Examiners assess an institution's sensitivity to market risk by monitoring the management of credit concentrations. In this way, examiners are able to see how lending to specific industries affects an institution. These loans include agricultural lending, medical lending, credit card lending, and energy sector lending. Exposure to foreign exchange, commodities, equities, and derivatives are also included in rating the sensitivity of a company to market risk. C - Capital adequacy HDFC Bank Capital Adequacy ratio 18.52 7.56 Debt equity ratio Advance to assets ratio 85.21 Federal Bank 14.14 10.76 82.79 Scheduled commercial banks in India are required to maintain a CAR of 9%. When we analyse HDFC Bank and Federal Bank in terms of CAR, both banks maintains a CAR which is higher than the stipulated rate. Out of the two banks, HDFC Banks performs marginally well. Advance to assets ratio shows aggressiveness of a bank in lending, thus resulting in better profitability. Higher the ratio better it is. HDFC Bank also performs well in it. In the case of debt equity ratio, higher ratio indicates less protection for the creditors and depositors in the banking system. So, here also HDFC is safer than Federal Bank. A – Asset quality HDFC Bank Total assets turnover 0.08 ratio Gross NPAs to total 1.26 assets Net NPAs to total assets 0.36 Federal Bank 0.08 2.84 1.31 In the case of asset quality, Federal Bank is doing well in maintaining assets turnover ratio and a good rate of Gross NPA as well as a better NPA rate in comparison with HDFC Bank. Federal Bank is the winner. M – Management efficiency HDFC Bank Business per employee 0.22 (In lakhs) Profit per employee (In 18.3 Crores) 15.35 Return on equity Federal Bank 0.10 20.05 10.06 When we analyse the management efficiency of HDFC Bank and Federal Bank, HDFC Bank is doing well in maintaining business per employee and return on equity. But, Federal Bank is ahead in maintaining profit per employee. E – Earnings quality HDFC Bank Operating profits to 0.19 total assets Net interest margin to 3.67 total assets 1.71 Return on asset Federal Bank -0.21 2.57 0.85 The above table clearly indicates that HDFC Bank is clearly ahead of Federal Bank in their earning ability. So, the earning skill of HDFC Bank management is good as compared to Federal Bank. L – Liquidity position Current ratio Quick ratio Cash deposit ratio HDFC Bank 0.04 16.62 5.75 Federal Bank 0.05 37.04 4.68 From the above table, it is clear that, Federal bank maintains more liquidity as compared to HDFC Bank as they maintain a current ratio and quick ratio more than HDFC Bank. But HDFC Bank have a hand on cash deposit ratio. Conclusion From the above CAMEL analysis between HDFC Bank and Federal Bank, it is understood that HDFC Bank is efficiently operating their business as they are the clear winner in capital adequacy, management efficiency and earning ability. In the case of liquidity position and in asset quality, Federal Bank has a slight advantage. So in CAMEL analysis, it is understood that size of the bank does not matter, only performance matters.
