Financial statements can look intimidating, with long lists of schedules and unfamiliar terms. Yet a bank’s balance sheet follows a logical pattern, and learning to read it opens the door to confident investing. Newcomers who track the HDFC Bank Share Price often begin by comparing quarterly profits, but deeper insight comes from understanding what lies underneath. The same principle applies to a vast public sector institution, where anyone studying the SBI Share Price will find that the story is told as much by assets and liabilities as by reported earnings.
The Two Sides of the Statement
On one side of the balance sheet stand the liabilities and capital: deposits, borrowings and shareholders’ funds. In other words, the sources of funds. On the opposite side are the assets: advances, investments, cash and fixed assets – in other words, the uses of funds.
Because of the leveraged nature of the banking activity, the changes in the value of assets, which impact the equity, are amplified many times over. This is why regulators focus so much on capital and why investors are so interested in the book value of assets.
Deposits and Borrowings
Deposits constitute the single biggest liability for a bank. Of interest are the trends in deposit growth, the CASA ratio, and the composition of deposits in retail and wholesale. The higher the proportion of retail deposits, the better, as they are usually more stable.
Borrowings, including the bonds issued and refinancing facilities availed by the bank, represent the second largest liability. Here, the dependence on market financing may be a concern for investors, as it may increase the cost of funding. A look at the maturity profile helps understand if the bank is investing short-term money in long-term assets.
Advances and Investments
Advances, or loans, are the biggest asset for the bank. The composition of the loans in retail, agriculture, MSME and corporate lending is important, as is the growth in secured and unsecured credit. Generally, a strong performance in secured lending is a positive sign.
The investments in government securities, which banks make to meet the statutory liquidity reserve requirements, form the second largest asset. Since these are high-grade instruments, the fluctuations in their prices due to interest rate changes impact the bank’s profit. The notes to the accounts reveal if the bank holds these to maturity or available for sale and, consequently, the extent of the price changes affecting the income statement.
Capital and Reserves
The shareholders’ funds represent the third pillar of the balance sheet – the core capital. The growth in reserves, which adds to the share capital, reflects positively on the net worth. The book value of the shares, or the net worth divided by the total number of shares outstanding, is a useful metric to track, as is the price-to-book ratio.
Of interest are the capital adequacy ratio, the proportion of core capital in it, and the overall level of reserves. A bank that maintains a strong capital position has the ability to grow without diluting the existing shareholders’ stake.
The Income Statement Connection
The profit and loss statement serves as the counterpart to the balance sheet. The net interest income, other income, operating expenses, and provisions for bad and doubtful debts are put together to arrive at the net profit. Return on assets and return on equity serve as crucial links connecting the income statement and the balance sheet. Essentially, it says how much profit the bank is able to generate from its assets and equity.
Ideally, a bank’s return on assets should be over one per cent, though it varies across different business models. Even a higher return on equity, while good, is not enough if it is driven by aggressive leverage. More useful is the trend of the return on assets or equity over a long period of time, rather than a single quarter or year, to indicate consistency in operations.
Notes, Footnotes and Management Discussion
The notes to the accounts contain a wealth of information. They detail contingent liabilities, related-party transactions, impaired loans, exposures to volatile sectors, and changes in accounting policies. The management discussion section contains information on the outlook, strategy, and risk exposures.
It is imperative to read through these sections carefully to understand the trends, both good and bad. Be on the alert while reading about changes in accounting policies, large one-time gains or losses, and explanations about weak performance quarters.
The Habit Building
Start by compiling a list of a few important ratios and tracking their changes quarter-on-quarter. It will reveal strengths and weaknesses of the bank before they show on the share price. As an investor, you begin to understand the balance sheet. And after that, nothing can stop you from becoming a better judge of the value of the stock.
