Saturday, 17 May 2014

A Quick Look At Indian Banks

Firstly a quote from Business Standard

© 2014 Business Standard Ltd. All rights reserved.

Banks - meaning basic commercial banks - can be notoriously difficult to value. Profits on a quarterly basis might mean nothing. One useful indicator is the interest rate trend. If interest rates are coming down, or are stable, it's likely to be good for banks. Lower interest rates create demand for credit, as well as improving the value of prior loans made at higher interest rates.

Another interesting number is the credit-deposit (C-D) ratio. If the C-D ratio is very low, it's an indication there isn't much demand for credit and banks will struggle to generate business. If it's too high, the banking system is likely to be stressed out by excessive demand. Apart from C-D , bad loans and requests for corporate debt restructuring are good indications of stresses on the banking system.

Apart from these, sensitivity to interest rate changes will always be a profound factor and it must be judged case-to-case.

What is fractional reserve?

Source: Business Standard:, © 2014 Business Standard Ltd. All rights reserved.

Banking works on the concept of fractional reserves. A bank keeps a fraction of the cash it receives in reserve and lends the rest. Say, a bank receives Rs 100 and it is required to maintain reserves of 10 per cent. It keeps Rs 10 in reserve, and lends out Rs 90. Out of that Rs 90, Rs 81 is lent on, with Rs 9 held as reserve. Out of Rs 81, 73 is lent on and so on.

Fractional reserves magically create more credit. But it also means that if depositors suddenly withdraw large amounts, a bank can go bust. High levels of interconnection between banks means that a run on a single bank can affect the entire banking system.

Further reading:

1. Second thoughts..

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