Accounts Project-Banking Sector

FINANCIAL ANALYSIS OF THREE MAJOR BANKS VIZ. SBI, AXIS BANK & HDFC BANK AND SECTOR OUTLOOK

Prepared by group 1- Apurba Mukherjee (14P189)- Hariharan Aravind (14P200)

- Nipun Jain (14P187)- Praveen Sharma (14P214)

- Surabhi Gulati(14P233) - Vaanya Kathuria(14P225)

FINANCIAL ANALYSIS OF THREE MAJOR BANKS VIZ. SBI, AXIS BANK & HDFC BANK AND SECTOR OUTLOOK

Bank is an institution that deals in money and its substitutes and provides crucial financial services.Banking Means "Accepting Deposits for the purpose of lending or Investment of deposits of money from the public, repayable on demand or otherwise and withdraw by cheque, draft or otherwise."

Banks are the most leveraged industry of any economy, so stability and soundness is an important parameter in the banking system. The main goal of banks in today’s financial condition is to maintain stability and make sure that they are resistant to outer shocks while at the same time being sensible and sound from inside. Hence, it is significant to calculate soundness across top banks in the country, spot the weaker sections of this sector, formulate appropriate policies and strategies to raise these sections and finally create an environment that leads this banking industry to converge in soundness and produce a consistently stable structure.

The primary function of a bank is to collect funds (deposits) at a lower interest rate and lend them out, at a higher interest rate. A bank makes money via Net Interest Income that is the interest earned on loans, minus interest paid on deposits.However, a sizable portion of the income comes from the fee charged on various services such as:

Demand Drafts Advisory Services to Corporate Trading Income Commission via selling other non-bank financial products such as

insurance and mutual funds

SCHEDULED COMMERCIAL BANKS

SCHEDULED CO-OPERATIVE BANKS

Regulator – Reserve Bank of India

The RBI is the Central Bank in India. The main objective of RBI is to provide the nation with a safer, more flexible and stable monetary and financial system.

Key Regulations Governing Banks

Basel III

Basel III is part of the continuous effort made by the Basel Committee on Banking Supervision to enhance the banking regulatory framework. It builds on the Basel I and Basel II documents, and seeks to improve the banking sector's ability to deal with financial and economic stress, improve risk management and strengthen the banks' transparency. A focus of Basel III is to foster greater resilience at the individual bank level in order to reduce the risk of system wide shocks.

In 2010, Basel III guidelines were released. These guidelines were introduced in response to the financial crisis of 2008. A need was felt to further strengthen the system as banks in the developed economies were under-capitalized, over-leveraged and had a greater reliance on short-term funding. Also the quantity and quality of capital under Basel II were deemed insufficient to contain any further risk. Basel III norms aim at making most banking activities such as their trading book activities more capital-intensive. The guidelines aim to promote a more resilient banking system by focusing on four vital banking parameters viz. capital, leverage, funding and liquidity.

Tier 1 Capital: Tier I capital is equal to sum of equity capital and disclosed reserves.Tier 2 Capital: Tier 2 capital is secondary bank capital that includes items such as undisclosed reserves, loss reserves, term debts etc.

Significance of Tier 1 and Tier 2 Capital: Tier 1 capital absorbs losses without a bank being required to cease

trading and Tier 2 capital absorbs losses if the bank winds-up its business.Thus, Capital adequacy ratio acts as a cushion in the event of loss or default, and protects the depositors.

Changes proposed in BASEL III over BASEL II norms:

a) Better Capital Quality: One of the key elements of Basel III is the introduction of much stricter definition of capital. Better quality capital means the higher loss-absorbing capacity. This in turn will mean that banks will be stronger, allowing them to better withstand periods of stress.

(b) Capital Conservation Buffer: Another key feature of Basel III is that now banks will be required to hold a capital conservation buffer. The buffer will be an additional 2.5% Common Equity Tier 1 capital requirement. The aim of asking to build conservation buffer is to ensure that banks maintain a cushion of capital that can be used to absorb losses during periods of financial and economic stress.

(c) Countercyclical Buffer: This is also one of the key elements of Basel III. The countercyclical buffer has been introduced with the objective to increase capital requirements in good times and decrease the same in bad times. The buffer will slow banking activity when it overheats and will encourage lending when times are tough i.e. in bad times. The buffer will range from 0% to 2.5% and will extend the capital conservation buffer previously described.

(d) Minimum Common Equity and Tier 1 Capital Requirements: The minimum requirement for common equity, the highest form of loss-absorbing capital, has been raised under Basel III from 2% to 4.5% of total risk-weighted assets. The overall Tier 1 capital requirement, consisting of not only common equity but also other qualifying financial instruments, will also increase from the current minimum of 4% to 6%. Although the minimum total capital requirement will remain at the current 8% level, yet the required total capital will increase to 11.5% when combined with the capital conservation buffer.

(e) Leverage Ratio: A review of the financial crisis of 2008 has indicted that the value of many assets fell quicker than assumed from historical experience. Thus, now Basel III rules include a leverage ratio to serve as a safety net. A leverage ratio is the relative amount of Tier 1 capital to total assets (not risk-weighted). This aims to put a cap on swelling of leverage in the banking sector on a global basis. 3% leverage ratio of Tier 1 will be tested before a mandatory leverage ratio is introduced in January 2018.

(f) Liquidity Ratios: Under Basel III, a framework for liquidity risk management will be created. A new Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) are to be introduced in a phased manner starting 2015 and 2018, respectively.

The Capital Adequacy Ratio as per the Basel Norms must be 9% i.e. RBI mandates 9% of the risk weighted loan as required capital for a bank.

Reserve Requirements

Reserve Requirements are imposed by the Central Bank where, a certain percentage of deposits taken, are to be maintained with the Central Bank.They are maintained in order to prevent banks from

suddenly running out of cash to pay depositors (liquidity risk) defaulting (default/credit risk for depositor)

In India reserve ratios are maintained in two ways: Cash Reserve Ratio (CRR) Statutory Liquidity Ratio (SLR)

CRR is a certain percentage of all deposits, which must be placed with the RBI in the form of cash. Currently CRR as mandated by RBI is 4%.

SLR is the chunk of securities that is to be used for buying Govt. Securities. SLR as mandated by RBI is 22%

Sector Analysis:

The Indian economy has been badly hit by the global slowdown. Also, domestic economy has been having its own set of problems. High inflation, subdued growth, slowing investments undesirable current account deficit levels, high fiscal deficit and battered currency have together made the growth visibility rather muted. The banking sector being the barometer of the economy, has succumbed to these challenges. Amidst these challenges the Indian banking system continues to deal with

improvement in operational efficiency and execution of prudent risk management practices.

RBI’s hawkish monetary policy stance in order to combat inflation has led to sharp increase in interest rates during FY13. Elevated costs of deposits and limited pricing power ensured margin pressures for most of the banks for major part of FY13. Indian banking industry, valued at Rs 77 trillion (Source: IBEF) is growing at a slower pace and plagued by bad loans. In what could be termed as a challenging year, FY13 witnessed steep increase in bad loans of Indian banks and turning them skeptical to extend loans to companies. As a share of sector loan book, the bad loans have gone up from 1.3% in March 2009 to 3.4% in March 2013. Public sector banks that account for 60% of the total banking assets have been the worst hit vis-a-vis its private and foreign counterparts.

Financial Statement Analysis for SBI, Axis Bank & HDFC Bank:

For the purpose of analysis of comparative financial performance of the select banks, we have taken the below mentioned factors

Capital Adequacy Debt Coverage Asset Quality Profitability Liquidity Investment Valuation

The capital adequacy of the Indian banks is now on par with international standards. The level of net NPAs has come down to very manageable levels. An issue that is in the forefront of banking reforms currently is that of bank consolidation. The present study is devoted to analyze the financial performance of SBI, Axis Bank and HDFC Bank.

A.Capital Adequacy:

It shows by and large financial condition of banks and also the capability of management to assemble the want for additional capital.

Capital Adequacy Ratio (CAR): The capital adequacy ratio is used to guarantee that banks can absorb a rational level of losses happened in operation i.e. bank capacity in meeting losses. The banks should have a CAR of 10 per cent. As per the latest RBI norms, CAR is set 9% for Existing Bank,

10% for Private Sector and banks having Insurance Underwriting business and 15% for Rural Banks.

Two types of capital are measured: tier one capital, which can absorb losses without a bank being required to cease trading, and tier two capital, which can absorb losses in the event of a winding up and so provides a lesser degree of protection to depositors. CAR is similar to leverage; in the most basic formulation, it is comparable to the inverse of debt-to-equity leverage formulations (although CAR uses equity over assets instead of debt-to-equity; since assets are by definition equal to debt plus equity, a transformation is required).Unlike traditional leverage, however, CAR recognizes that assets can have different levels of risk.

Capital adequacy ratios (CARs) are a measure of the amount of a bank's core capital expressed as a percentage of its risk-weighted asset and it is also known as "Capital to Risk Weighted Assets Ratio (CRAR)."

CAR = (Tier 1 Capital + Tier 2 Capital)/Risk Weighted Assets

Tier I Capital is actual contributed from equity plus retained earnings. Tier II capital includes preference shares plus 50% of subordinated debt.

2014 2013 2012 2011 2010SBI 12.96 12.92 13.86 11.98 13.39Axis Bank 16.07 17.00 13.66 12.65 15.80HDFC Bank

16.07 16.80 16.52 16.22 17.44Source: Moneycontrol.com

Higher ratio indicates that disbursement of funds is safer and that it can handle properly any unexpected losses of banking. From the above table we can conclude that all the three banks are good with respect capital adequacy and HDFC stand out amongst them with the highest average capital adequacy ratio. An adequate capital is required to run the banking business and any shortcoming of funds for operation but very high level of CAR badly affects the investment capacity of the bank.

B.Debt Coverage:

Credit Deposit Ratio: It is the ratio of how much a bank lends out of the deposits it has mobilized. It indicates how much of a bank's core funds are

being used for lending, the main banking activity. A higher ratio indicates more reliance on deposits for lending and vice-versa.

Credit Deposit Ratio=Total Advances/Customer Deposit

2014 2013

2012 2011 2010

SBI 86.84 85.17

- 36.36 75.96

Axis Bank 80.03 77.58

76.26 74.65 71.87

HDFC Bank 45.66 78.06 76.02 72.44

C.Asset Quality:

The quality of assets is an important parameter to gauge the strength of a bank. The logic behind calculating the asset quality is to determine the factor of non-performing assets (NPA) as a fraction of the bank total assets. The ratios required to review the asset quality are:

Percentage of Net NPAs: This ratio calculates the competence of bank in credit risk and debt recovery.

Return on total asset (ROA): It calculates employment of assets in investment

Net NPAs = Gross NPAs – Provisions / Gross Advances – Provisions

Causes of NPA

The banking sector has been facing serious problems of the rising NPAs. Some of the main causes of NPA are ineffective recovery, willful defaults, natural calamities, industrial sickness, sluggish legal system, unfavorable business cycle, defective lending process, inappropriate technology, poor quality management, managerial deficiencies and absence of monitoring and follow up.

Impact of NPA

NPA is a double edge weapon. On one hand, it does not generate income for the banks, and at the other banks are required to make provisions for such NPAs from their current profits. Because of the money getting blocked the prodigality of bank decreases not only by the amount of NPA but NPA lead to opportunity cost also as that much of profit invested in some return earning

project/asset. So NPA doesn’t affect only the current profit but also future stream of profit, which may lead to loss of some long-term beneficial opportunity. Further, the recovery process adds to the woe of time for the employees and management. Apart from internal and external complexities, increases in NPAs directly affects banks’ profitability sometimes even their existence.

Percentage of Net NPAs

2014 2013 2012 2011 2010SBI 2.57 2.10 1.82 1.63 1.72Axis Bank 0.40 0.32 0.25 0.26 -HDFC Bank

0.30 0.20 0.20 0.20 -Source: Moneycontrol.com

Return on total asset (ROTA) %

2014 2013 2012 2011 2010SBI 0.65 0.91 0.88 0.71 0.88Axis Bank 1.78 1.70 1.68 1.68 -HDFC Bank 2.00 1.90 1.80 1.60 -

SBI bank has highest NPA level followed by Axis Bank and then HDFC while HDFC bank has highest ROA. This shows poor asset quality of SBI.

D.Profitability:

I. Net Interest Margin – It is the performance metric that examines how successful a firm's investment decisions are compared to its debt situations. A negative value denotes that the firm did not make an optimal decision, because interest expenses were greater than the amount of returns generated by investments.

2014 2013 2012 2011 2010

SBI 2.9 3.0 3.3 2.9 2.4Axis Bank 3.2 2.9 2.9 2.8 2.9HDFC Bank

3.9 4.1 4.1 4.2 4.0

II. Net Profit Margin (NPM): NPM studies the absolute value of a profit level as a percentage of net income to sales revenues , a comprehensive measure of a company's profitability

2014

2013 2012 2011 2010

SBI 7.03

10.39 9.68 7.58 10.54

Axis Bank 16.34

15.35 15.47 17.12 16.10

HDFC Bank

17.28

16.04 15.88 16.18 14.76

III. Return on Net worth (RON) or Return On Investment (ROI):Return on shareholders’ investment, popularly known as return on investment or return on shareholders’ funds is the relationship between net profits and the proprietors’ funds. Net profit after interest and tax is divided by the shareholders’ funds. This ratio is one of the most important ratios used for measuring the overall efficiency of a bank. The primary objective of business is to maximize its earnings and this ratio indicates the extent to which this primary objective of business is being achieved. This ratio is of a great importance to the present and prospective shareholders as well as the management of the bank.

Return on Net Worth=Net Profit/Net-worth

2014

2013 2012 2011 2010

SBI 9.2 14.26 13.94 12.71 13.89Axis Bank 16.

2615.64 18.59 17.83 15.69

HDFC Bank

19.50

18.57 17.26 15.47 13.70

IV. Operating Profit per share (OP): This calculates bank earnings from operations for each rupee spent as working fund per share.

2014

2013 2012 2011 2010

SBI 199.45

236.63 271.65 165.38 229.63

Axis Bank 93.96

66.33 56.94 50.50 97.29

HDFC Bank

29.65

21.97 18.11 83.56 106.25

E. Liquidity Ratios:The liquidity refers to the maintenance of cash, bank balance and those assets which are easily converted into cash in order to meet the liabilities as and when arising. So, the liquidity ratios examine the bank’s short-term solvency and its ability to pay-off the liabilities. These ratios as a group are intended to provide information about a bank’s liquidity and the primary concern is the bank’s ability to pay its current liabilities. These ratios focus on current assets and current liabilities. If a bank does not have sufficient liquidity, it may not be in a position to meet its commitments and thereby may lose its credit worthiness.

1. Current Ratio: Current ratio may be defined as the relationship between current assets and current liabilities. Current assets include cash in hand, balance with RBI, balance with other banks (both in India and abroad), money at call and short notice and stock. Current liabilities include short-term borrowings, short-term deposits, bills payables, bank over draft and outstanding expenses. It is a measure of general liquidity and it is widely used to make the analysis of a short-term financial position or liquidity of a bank. It is calculated by dividing the total current assets by total current liabilities.

Current Ratio = Current Assets/ Current Liabilities

2014

2013 2012 2011 2010

SBI 0.03

0.04 0.05 0.04 0.04

Axis Bank 0.03

0.03 0.03 0.02 0.03

HDFC Bank

0.06

- 0.08 0.06 0.03

2. Liquidity / Quick Ratio: It is defined as the relationship between quick or liquid assets and current or liquid liabilities. Liquid assets include cash in hand, balance with RBI, balance with other banks (both in India and abroad) and money at call and short notice. Current liabilities include short-term borrowings, short-term deposits, bills payables and outstanding expenses.

Quick Ratio=Quick Assets/Current Liabilities

2014

2013 2012 2011 2010

SBI 13.88

12.15 12.05 8.50 9.07

Axis Bank 18.57

20.10 21.63 19.60 19.19

HDFC Bank

8.55

7.84 6.20 6.89 7.14

3. Debt-Equity Ratio: It is arrived at by dividing the total borrowings and deposits by shareholder’s net worth, which includes equity capital and reserves and surpluses. This ratio is calculated to measure the relative claims of outsiders and the owners against the bank’s assets.

Debt-Equity Ratio = Long-term Liabilities/Shareholders Funds

2014

2013 2012 2011 2010

SBI 11.79

12.16 12.43 14.37 12.19

Axis Bank 7.35

7.63 9.65 9.96 8.81

HDFC 8.4 8.18 8.24 8.22 7.78

Bank 5

F. Investment Valuation:

I. Investment Valuation Ratio

P/E Ratio

2014SBI 16.89Axis Bank 15.17HDFC Bank 23.18

Earnings per share

2014

2013 2012 2011 2010

SBI 145.88

206.20 174.46 116.07 144.37

Axis Bank 132.33

110.68 102.67 82.54 62.06

HDFC Bank

35.34

28.27 22.02 84.40 64.42

Dividend per share

2014

2013 2012 2011 2010

SBI 30 41.50 35 30 30Axis Bank 20 18 16 14 12HDFC Bank

6.90

5.50 4.30 16.50 12

Short Term Investment:State Bank of India

52 WK LOW/HIGH 1455.00 / 2833.85 Current Share Price 2515.40Beta value 1.36P/E 16.89

Axis Bank

52 WK LOW/HIGH 152.80 / 419.20Current Share Price 415.75Beta Value 1.76P/E 15.17

HDFC Bank:

52 WK LOW/HIGH 558.40 / 863.80Current Share Price 848.75Beta Value 1.09P/E 23.18

Conclusion:Current share values of alt these shares are close to 52 week high, however Beta value of Axis bank is much higher than those of SBI and HDFC (1.76, 1.36 and 1.09 respectively). Moreover, among the three banks P/E Ratio is minimum for Axis Bank followed by SBI and HDFC bank (15.17, 16.89 and 23.18 respectively)

Order of Preference

SBI 2Axis Bank 1HDFC Bank 3

Long term Investment:

DPS/EPS

RON NPM NIM Percentage of

Net NPASBI 0.2056 9.2 7.03 2.9 2.57Axis Bank

0.1511 16.26 16.34 3.2 0.40

HDFC Bank

0.1952

19.50 17.28 3.9 0.30

Among the three banks HDFC offers maximum Returns on Net worth and also it has got highest Net profit Margin and net interest margin and a healthy DPS/EPS Ratio.

SBI although have highest DPS/EPS ratio but its return on net worth net worth is relatively less and so is net profit margin and net interest margin. Also SBI have Highest Net NPA which indicates that in long term its chances of generating good profit are less.

Order of Preference

SBI 3Axis Bank 2HDFC Bank 1

LendingThe interbank lending market is a market in which banks extend loans to one another for a specified term. Most interbank loans are for maturities of one week or less, the majority being overnight. Such loans are made at the interbank rate.

When reference is made to the Indian interest rate this often refers to the repo rate, also called the key short term lending rate. If banks are short of funds they can borrow rupees from the Reserve Bank of India (RBI) at the repo rate, the interest rate with a 1 day maturity. If the central bank of India wants to put more money into circulation, then the RBI will lower the repo rate. The current repo rate is 8%.

The interbank lending market refers to the subset of bank-to-bank transactions that take place in the money market. The money market is a subsection of the financial market in which funds are lent and borrowed for periods of one year or less. Funds are transferred through the purchase and sale of money market instruments—highly liquid short-term debt securities. These instruments are considered cash equivalents since they can be sold in the market easily and at low cost. They are commonly issued in units of at least one million and tend to have maturities of three months or less. Since active secondary markets exist for almost all money market instruments, investors can sell their holdings prior to maturity. The money market is an over-the-counter (OTC) market.

Interbank loans are important for a well-functioning and efficient banking system. Since banks are subject to regulations such as reserve requirements, they may face liquidity shortages at the end of the day. The interbank market allows banks to smooth through such temporary liquidity shortages and reduce 'funding liquidity risk'.

Banks require short term loans to cover short term withdrawal requirements of depositors.

http://en.wikipedia.org/wiki/Money_market

http://en.wikipedia.org/wiki/Over-the-counter_(finance)

http://en.wikipedia.org/wiki/Secondary_market

http://en.wikipedia.org/wiki/Money_market#Common_money_market_instruments

Short Term Lending

Ratio Analysis:

Credit Deposit Ratio=Total Advances/Customer Deposit

5 Year Average Value RankState Bank Of India 71.08 2Axis Bank 76.08 1HDFC Bank 68.04 3

Current Ratio

5 Year Average Value RankState Bank Of India 0.04 2Axis Bank 0.03 1HDFC Bank 0.05 3

Operating Profit

Five-year CAGR of operating profit (%)

Rank

State Bank Of India 22 3Axis Bank 31 1HDFC Bank 29 2

Final Ranking1. Axis Bank2. SBI3. HDFC Bank

Long Term Lending

Capital Adequacy Ratio (CAR)5 Year Average Value Rank

State Bank Of India 13.02 3Axis Bank 15.03 2HDFC Bank 16.61 1

Percentage of Net NPAs5 Year Average Value Rank


Return on total asset (ROTA) %5 Year Average Value Rank


Net Interest Margin5 Year Average Value Rank


Debt-Equity Ratio = Long-term Liabilities/Shareholders Funds5 Year Average Value Rank


Final Ranking

1. HDFC Bank2. Axis Bank3. SBI

STRATEGIC POINT OF VIEW

SBI:

1. The percentage of net NPA of SBI has been increasing from 1.72 in 2010 to 2.57 in 2014 so SBI should look forward to reduce its percentage of net NPA.

2. It should reduce its operating expenses as they have increased by 29,284 Cr in 2013 to 35,725 Cr in 2014.

3. It should look forward to deploy a more quantitative and statistical approach to risk management by proactive adjustments of risk weights for loans depending on economic cycle.

Axis Bank:

1. The percentage of net NPA of axis bank has been increasing from 0.26 in 2011 to 0.40 in 2014 so axis bank should look forward to reduce its percentage of net NPA.


3. It should also focus on increasing its presence in the rural markets which is a relatively new segment for the private sector banks.

HDFC Bank:

1. The percentage of net NPA of HDFC has increased from 0.20 in 2010 to 0.30 in 2014 so HDFC bank should look forward to reduce its percentage of net NPA.


3. It should also focus on increasing its presence in the rural markets which is a relatively new segment for the private sector banks.

Conclusion:

India’s banking industry is primarily focusing on servicing clients as well as improving upon its technology infrastructure. Constant increase in number of internet users on desktops as well as mobile handsets is allowing this sector to focus on improving customer experience.Current scenario: State Bank of India has announced a one-year rural fellowship programme 'SBI Youth for India (SBI YFI)' for 2014 to draft the country's youth to become change agents in the country's rural regions. This is a program for change-driven youth of India, giving them a chance to lead and make a difference. HDFC Bank plans to tap the equity markets to raise funds to enhance capital base and lending.

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Accounts Project-Banking Sector