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This is the second article in a series on understanding bank stocks in which I will
discuss the basics of a bank income statement.
In the first article I had discussed the basics of a banks balance sheet. Reading it
before this article, will be helpful.
Fiscal 2012
Fiscal 2013
% change
Interest income
335.42
400.75
19.5%
Interest expense
228.08
262.09
14.9%
107.34
138.66
29.2%
- Fee income
67.07
69.01
2.9%
- Treasury income
(0.13)
4.95
7.36
9.12
23.9%
0.72
0.38
-47.2%
182.36
222.12
21.8%
78.50
90.13
14.8%
Non-interest income
Operating income
Operating expenses
Operating expenses
78.50
90.13
14.8%
103.86
131.99
27.1%
15.83
18.03
13.9%
88.03
113.96
29.5%
23.38
30.71
31.4%
64.65
83.25
28.8%
Operating profit
The two main heads in income are net interest income which is earned from lending
activities. As I explained also in the last article, the bank pays customers interest on
their deposits and it earns interest on the loans it extends to borrowers. The
difference between the interest earned and interest expense is the net interest
income or NII.
Fee income is earned from loan processing fees, transaction fees, credit card fees and
service charges. Think of the recent SMS alerts for which banks have started charging
customers. If you want an attested printed account statement some banks charge you
a small fee. All these items add up to the fee income for a bank.
Fiscal 2013
% change
Interest income
335.42
400.75
19.50%
Interest expense
228.08
262.09
14.9
107.34
138.66
29.2
3,932.59
4,465.40
13.5
3,603.51
4,073.47
13.00%
2.73%
3.11%
NA
Average yield
8.53%
8.97%
NA
6.33%
6.43%
NA
Interest spread
2.20%
2.54%
NA
Net interest margin is a parameter that is of great interest to a bank stock investor. It
is the net interest income divided by the interest earning assets.
NIM tells you about the profitability of the core lending business of the bank. Here I
will ask you to link your knowledge of CASA from the previous article.
It is evident that the higher the proportion of CASA deposits in the total deposits, the
It is evident that the higher the proportion of CASA deposits in the total deposits, the
lower will be the interest expense. A bank can choose to lend at attractive rates (lower
than competitors) and still maintain a healthy NIM if its interest expenses paid to
depositors are low.
This is one lever.
Another lever is the interest earned. Now, this is a tricky subject. A bank can earn
more interest on a loan by charging more than the market. But why will a borrower
pay up a relatively high interest rate?
Possibly, if other banks refuse to lend to it. Why would they not lend to it?
Maybe it is a risky proposition to begin with. Maybe, the other banks do not have
strong credit teams or understanding of the borrowers situation. They possibly are
not good at structuring a loans terms and conditions and the amount and type of
security they take from the borrower.
Contrary to this, a bank may be able to do exactly the opposite. They can contain the
risk through innovative structuring or by taking adequate security, they can take this
business which others have rejected. They can earn a high interest rate on loans
which others are not in a position to make. This will give them a relatively high NIM
even with roughly the same cost of funding as other banks.
Needless to say, this entails higher risk of things going wrong. It is a fine line that the
bank must then walk.
at a fast clip in most banks as compared to the traditional net interest income.
In ICICI Banks case, the fee income to operating income (69.01 divided by 222.12) is
37%.
The net interest income to operating income (138.66 divided by 222.12) is 59%.
Provisions
This is another important metric to track. This assumes much more importance
especially in times of economic stress when bad loans start rising.
Provisions are mandatory as per RBI guidelines. They force the bank to keep aside
some of their income even if all is good (provisions on standard assets). They also
force the bank to recognize bad loans and deduct appropriate amounts when there
are signs that loans are going bad or have gone bad (provisions on substandard
assets and NPAs).
The better the credit process, the better will be the quality of the loan book. In bad
times, lesser loans will go bad. Correspondingly, lesser provisions will need to be
deducted from income.
Reading material
The RBI website is the base for any serious understanding of bank financial
statements and analysis.
I recommend reading the RBI master circular given below. This will explain how assets
are classified on a banks balance sheet. This will tell you more about NPAs and how a