How to check the financial health of a bank
Key Indicators of Financial Health of a Bank
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Capital Adequacy Ratio (CAR): It is one of the most important indicators which measures a bank's capital against its risk-weighted assets and liabilities. This ratio is crucial because it tells you how much cushion a bank has to absorb losses before it becomes insolvent. Generally, a high CAR means that a bank has cushion to absorb losses without becoming insolvent.
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Liquidity Ratio: This ratio highlights the proportion of highly liquid assets held by the bank to meet its short-term obligations. A bank with a high liquidity ratio is better placed to handle unexpected withdrawals or financial shocks. In general, this ratio shows how much high quality liquid assets a bank holds that are sufficient to cover 30 days of cash outflows.
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Non-performing assets (NPAs): It is one of the most critical indicators of a bank's financial health. NPAs refer to the classification of loans which are not being repaid and have been tagged as default loans. As per RBI regulations, if interest on a loan is not paid for 3 months (90 days), the loan is categorised as a non-performing asset.
- Net interest margin (NIM): The NIM is a profitability indicator that highlights the likelihood of a bank thriving over a long period of time. It is the difference between interest earned by a bank on loans and the interest it pays on deposits. For better understanding of a bank's performance, one can also look at both NIM and NPAs together. For example, if the NPAs of a bank are rising then the interest earned by the bank should fall, resulting in decline of the NIM.
Analysing Financial Statements
Conclusion
Disclaimer
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