SBM, NMIMS

Case Study on HDFC Bank

CBM Assignment

R0hit Agarwal – G003Vikrant Dhall – G016

Rohit Garg – G022Priyanshi Goel – G026

Kalyan Srivastava – G043Aditya Rane – G045Sahil Sehgal – G050

HDFC Bank Case StudyOn a bright Sunday morning of July 2015, sitting in a French restaurant, sipping his wine and looking at the wide-open skies munching on his bruschetta, Aditya Puri meditated on a question that had been keeping his mind pre occupied for a while now. An IT graduate from a reputed engineering college in India with an MBA and wide industry experience he had successfully overcome almost all challenges that came his away.

“We have no stress on our portfolio, healthy margins, a distribution network that’s spread across the length and breadth of the country, cutting-edge technology–and enough capital but the road is long, challenges come in different ways and HDFC will continuously strive to work on the same” – Aditya Puri.

Mr Puri recalls the day he joined HDFC. While moving across levels in HDFC, he comes across as a practical thinker to the problems. He led HDFC’s acquisition of Amanda Capital that received much appreciation from the industry. As a CMD, handling vast group of 6.5 billion USD, HDFC had grown to one of the top three fund houses in country under his watch.

Mr. Puri has always believed in being most transparent in working across groups. With banking industry growing at 20% CAGR, he is now worried about the performance his banks. He understands that investors these days are looking for returns/funds divided allocations as fixed income and corporates expect lower cost of acquiring funds. However, due to sudden volatility in the markets the targets for his bank’s performance have been questioned. Being a person with utmost professional etiquette he is now wondering how can things come under control and what steps does he need to take to make HDFC the number in banking across country.

Economic Reforms in India since 1991: Had Gradualism Worked?

India’s economic performance in the post-reforms period had many positive features. The CAGR1 in the 5 year period from 1992-93 to 1997-98 was around 6.0 per cent. This growth record is only minutely upper than the yearly average of 5.8 per cent in the 1980s, but it can be argued that the 1980s growth was un achievable, helped by a accumulating of foreign debt which culminated in the crisis of 1991.

However, the ten-year CAGR performance does not highlight the fact that although the economy grew at an impressive 6.7 per cent in the first five years after the reforms. Opinions on the causes of the growth deceleration vary. Global economic growth was slower in the latter half of the 90s and that could have a little lowering effect, but India’s dependence on the global economy is not large enough for this to account for the slowdown.

1 CAGR means Compounded Annual Growth Rate

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The five major areas covered by the reform program: fiscal deficit reduction, industrial and trade policy, agricultural policy, infrastructure development and social sector development.

Foreign Direct Investment

Liberalizing FDI was a crucial part of India’s reforms, driven by the belief that this will move the total value of saving in the country, improving production technology, and increase access to global markets. The move allows 100% foreign belonging in a large number of industries and majority belonging in all except banks, insurance companies, telecommunications and airlines.

These reforms have created a very different challenging environment for India’s industry than existed in 1991, which had led to significant changes. Indian companies have upgraded their technology and expanded to more efficient ways of production. They have also restructured through mergers and acquisitions and refocused their activities to concentrate on areas of competence.

Financial Sector Reform

Banking Changes included: (a) measures for liberalization, like eliminating prior approval of the Reserve Bank of India for large loans, and reducing the statutory requirements to invest in government securities; (b) measures designed to increase financial soundness, like introducing capital adequacy requirements and other prudential norms for banks and strengthening banking supervision; (c) measures for increasing competition like more liberal licensing of private banks and freer expansion by foreign banks. These steps have produced some positive outcomes.

India’s banking reforms differ from those in other developing countries in one important respect and that is the challenge towards PSB, which controlled the banks.

The insurance sector (including pension schemes), was a public sector monopoly at the start of the reforms. The need to open the sector to private insurance companies was recommended by an expert committee (the Malhotra Committee) in 1994, but there was strong political resistance. It was only in 2000 that the law was finally amended to allow private sector insurance companies, with foreign equity allowed up to 26 per cent, to enter the field.

Privatization

Initially, the government adopted a limited approach of selling a minority stake in public sector enterprises while retaining management control with the government, a policy described as “disinvestment” to distinguish it from privatization. This policy had very limited success. Disinvestment receipts were consistently below budget expectations and the average

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realization in the first five years was less than 0.25 per cent of GDP 2 compared with an average of 1.7 per cent in seventeen countries reported in a recent study.

An important recent innovation, which may increase public acceptance of privatization, is the decision to earmark the proceeds of privatization to finance additional expenditure on social sector development and for retirement of public debt. Privatization is clearly not a permanent source of revenue, but it can help fill critical gaps in the next five to ten years while longer-term solutions to the fiscal problem are attempted.

Social Sector Development in Health and Education

Much of the debate in this area had focused on what had happened to expenditure on social sector development in the post-reform period. Closing the social sector gaps between India and other countries in Southeast Asia will require additional expenditure, which in turn depends upon improvements in the fiscal position of both the central and state governments.

Some of the issues to social development being lack of resources, as when the bulk of the budget is absorbed in paying salaries , leaving little available for medicines in clinics or essential teaching aids in schools. There are also governance problems such as nonattendance by teachers in rural schools and poor quality of teaching.

Using all such LPG reforms, HDFC bank, which was promoted by Housing Development Finance Corporation, a premier housing finance company, was incorporated in 1994.

Indian Banking Industry

Indian banking is the lifeline of the nation and its people. A progressively growing balance sheet, higher pace of credit expansion, expanding profitability and productivity akin to banks in developed markets, lower incidence of non-performing assets and focus on financial inclusion have contributed to making Indian banking vibrant and strong. Indian banks have begun to revise their growth approach and re-evaluate the prospects on hand to keep the economy rolling. The way forward for the Indian banks is to innovate to take advantage of the new business opportunities and at the same time ensure continuous assessment of risks.

The Indian Banking industry, which is governed by the Banking Regulation Act of India, 1949 can be broadly classified into two major categories, non-scheduled banks and scheduled banks. Scheduled banks comprise commercial banks and the cooperative banks. In terms of ownership, commercial banks can be further grouped into nationalized banks, regional rural banks and private sector banks.

The entire range of banking operations are segmented into four broad heads- retail banking businesses, wholesale banking businesses, treasury operations and other banking activities. Banks have dedicated business units and branches for retail banking, wholesale banking.

2 GDP means Gross Domestic Product

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Over the last three decades, there has been a remarkable increase in the size, spread and scope of activities of banks in India. The business profile of banks has transformed dramatically to include non-traditional activities like merchant banking, mutual funds, new financial services and products and the human resource development.

The products of the banking industry broadly include deposit products, credit products and customized banking services. Apart from the generic products like deposits (demand deposits – current, savings and term deposits), loans and advances (short term and long-term loans) and services, there have been innovations in terms and products such as the flexible term deposit, convertible savings deposit. Innovations have been increasingly directed towards the delivery channels used, with the focus shifting towards ATM transactions, phone and internet banking. Product differentiating services have been attached to most products, such as debit/ATM cards, credit cards, nomination and demat services.

Other banking products include fee-based services that provide non-interest income to the banks. Corporate fee-based services offered by banks include treasury products; cash management services; letter of credit and bank guarantee; bill discounting; foreign exchange services; and other value added services.

The banks are compared on various parameters. Amongst them, the most vital is NPA ratio. Net NPA ratio is simply that number adjusted for provisions for losses and not received interest. Exhibit 1.

Other important ratios would include:

Credit to deposit ratio: This ratio indicates how much of the advances lent by banks is done through deposits. It is the proportion of loan-assets created by banks from the deposits received.

Capital adequacy ratio: A bank's capital ratio is the ratio of qualifying capital to risk adjusted (or weighted) assets. The RBI has set the minimum capital adequacy ratio at 9% for all banks.

Provision coverage ratio: It is a measure that indicates the extent to which the bank has provided against the troubled part of its loan portfolio.

Return on assets ratio: Returns on asset ratio is the net income (profits) generated by the bank on its total assets (including fixed assets).

Success Story of HDFC Bank

For HDFC bank, a CASA3 ratio of 44%, NIM4 of 4.2%, and customer base growth of 35% CAGR since 2001 have come by simply following a conservative approach to banking. When the economy grows by x, banking industry grows by 2.5x and HDFC bank has grown at 3-

3 CASA means Current accounts, savings accounts (cheap source of funds for banks)4 NIM means Net interest Marging i.e. difference of interest earned and interest expended

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3.5x compared to peers. So how has the bank managed to outperform its peers? The answer is in the “quality of growth”.

Market Penetration Strategy

A conservative approach, in the context of HDFC Bank, means the bank did not compromise on margins and asset quality risks and has waited for the right opportunities. During the first decade, the focus was on urban centres, but today semi-urban and rural areas generate a large chunk. In the past decade, 80% of their income came from the top 15 cities; today 40% comes from semi urban and rural areas. That strategic shift happened as the bank looked to morph itself into a banker for the bottom of the pyramid. The management plans across three horizons in the future:

i. the opportunity that is there currently in the market,ii. a current idea that will become a big business in five years, and

iii. bottom of the pyramid which can be reached through their services and new products required for it

Even on the non-interest based income, the bank does not lie on investment banking and related activities as compared to its peers. Its main strengths in fee-based services are in corporate banking - transaction banking, loan processing, private banking, forex services - and third party distribution.

Balancing – Quality & Quantity

Aditya Puri managed the customer acquisition on both retail and corporate side very well for stability in profits. In years leading to 2008 crises, when retail was the main driver of growth, many banks were not growing wholesale or corporate banking and therefore suffered when retail lending slowed in 2008. HDFC Bank continued its focus on both, retail and corporate, and with its diversified product portfolio managed top line and bottom-line stability. In an under-banked country, growing fast is not a big issue, but growing while maintaining the margins is a completely different game. The bank's net interest margins are amongst the highest in the industry. Over last seven years, the Bank NIM stands at 4.4% versus peer group average of 2.8%.

Even in its beginning, HDFC Bank focused more on quality assets and less on pace of growth, so NPAs were few. Thus, while other banks were spending a lot of time on legacy issues and salvaging bad loans, HDFC Bank focused on growth when the markets grew. It also helped that in that era, bank shares (other than SBI's) were not sought after. Consequently, Puri and his team were not obsessed with valuation. They had no compulsion to grow the balance sheet at a fast pace.

A Cautious Banker

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A cautious banker, Puri will not venture into a product headlong — it is a deliberate process of learning, adapting, creating viability, and then expanding gradually. In category after category where the bank is a leader — personal loans, gold loans, microfinance, two-wheelers, crop loans — it has been the same, deliberate process.

For example in gold loans business, when retail banks were allowed to give loans against gold, HDFC Bank did not blindly follow ICICI Bank in entering the retail loan space. It waited for the market to mature, practices to settle in, and the industry got a sense of the default pattern, particularly in products like credit cards and personal loans. HDFC bank is a leader in credit cards market even after it being a late entrant. While other banks focused on looking out for new customers for their credit cards business, which had resulted in delinquencies rising up in 2008-10, Aditya Puri focused on selling cards to its own internal customers and today 70% of the credit cards are issued to internal customers.

Similarly, due to Puri's experience at Citi, the bank mastered that which no bank could. It entered the unchartered territory of financing stockbrokers, giving guarantees, extending loan against shares to retail investors. Armed with proper risk management techniques, it associated itself in every way a bank with the stock market. Today more than 50% of the stock exchange settlement happens through the bank.

A tight rope on bank’s operations

"Given that Mr Puri has steered affairs of the bank since the inception of the bank and the Bank has followed a consistent strategy since then. He should be credited for providing the right direction and strategy, building the right team and ensuring the execution" said Lumba of JM Financial. Through a delegating leader with a robust system of reviews and "special reviews", Aditya Puri admits he may have a disproportionate say in strategy. For a man who come in to office at 8.45 am and leaves at 5.30 pm, he runs a tight ship with a hands-on approach: meeting lots of employees and customers, visiting branches, and keeping a hawk-eye on things like cost, among others.

CEO’S Vision and Major Focus Areas

For Mr. Puri the main aim is not to make profit but to make the financial lives of the bank’s customer’s simple using technology. He identified digital banking as the next big opportunity and is focused on creating a world-class Indian bank. He does not want HDFC to compete with any single bank per se but wants to learn from different banks that have set a benchmark in areas like Virtual Bank, expansion in rural areas, maintaining good ROA. The bank wants to be a leader in the digital banking era by providing customers very flexible and innovative products. Currently, HDFC Bank accounts for 40% of all ecommerce transactions. With their own digital wallet PayZapp, they want to gain a market share and encourage other non-

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LEARN ADAPT VIABILITY EXPAND

HDFC bank account holders to join them as well. Because of the share in commercial transactions, it will be easy for the bank to get customers for the digital wallet. Another major focus area in the era of big data is use of analytics to use internal and external data, track customer behaviour, employ big data and use social media. HDFC Bank also needs to boost revenues from rural India.t around 55 per cent of HDFC Bank's branches are in the rural and semi-urban areas. The bank is also opening 90 per cent of its new branches outside metros and semi-urban areas. Mr. Puri expects that the share of revenues of semi-urban and rural branches will grow from 15 per cent to 35 per cent in the next five years, which is a good number, considering their aim of increasing the share of rural business to 50 per cent in 5 years.

Transformation Journey

HDFC Bank began by offering loans to blue chip companies. Gradually, it attached itself to India’s emerging salaried class. With the no of young professionals ever increasing, it came up with new products and offerings to create and maintain a reliable consumer base.

It aims to digitise all its offerings to the consumers. Currently, more than 75% of the transactions could be executed on a cell phone, barring deposit or withdrawing cash. Among the total no of mobile banking transactions, 38.2% are done on HDFC’s platform whereas 17% are done on PSB’s platforms, which account for more than 70% of the banking assets in the country.

It reinforces this culture in the organisation by asking senior managers to come up with ideas to digitise its current processes. Then, those ideas are implemented on a smaller scale and eventually scaled up, if successful.

Let us look at some examples:

Favourite Transaction – Usually an ATM cash deposit transaction involves nine screens taking 80 sec, on an average. HDFC came out with a feature, which enabled customers to save their favorite transaction so that the next time they visited an HDFC ATM, they just had to go through five screens, which saved around 40% of their time.For HDFC, it meant a reduction of 21 lacs hours per year thereby reducing long waiting queues outside its ATMs and lesser demand for infrastructure.(~24 cr annual transactions)

Co-Branded Cards – HDFC launched India’s first co-branded e-commerce credit cards(Exhibit 6), in collaboration with Snapdeal, an Indian online marketplace, aimed at tier 2 and tier 3 cities in India, which account for 70% of Snapdeal’s total orders. In addition, majority of these orders are based on cash on delivery, as rural/semi-urban India is still uncovered by banks.The features of this card include:

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i. New customers will get bonus gift of Rs 500 reward point, meant for spending on Snapdeal

ii. On spending more than Rs 5000, customers can get flat cash back of Rs 500iii. 10% cash back while using Freechargeiv. 5% cash back on Ola Cabsv. Rs 1000 cash back while spending Rs 5000 on Cleartrip app for hotel bookings

vi. Exclusive Rewards Program, like 2 time reward point while spending Rs 150 on a special; category of user’s choice

Start-up Village - Start-up Village is a not-for-profit business incubator based in Kochi, Kerala, India. Started in April 2012, the organisation's aim is to launch 1,000 technology startups over the next ten years and start the search for the next billion-dollar Indian company. [1] It focuses primarily on student startups and telecom innovation. India’s first [2] incubator is funded jointly by the public and private sector. As of October 2013, It has incubated 450 startups. The promoters include Department of Science and Technology, Government of India, Government of Andhra Pradesh, Technopark, Trivandrum and MobME Wireless. Kris Gopalakrishnan, co-founder of Infosys and an IT entrepreneur from Kerala, is the chief mentor.In association with Startup Village, HDFC launched a digital account opening system & credit card for start-ups (Exhibit 6). That provides low cost deposits for the bank and helps it come up with innovative apps. For e.g. Chillr.

Personal Loans in 10 Sec – Normally, getting a personal loan takes a few days. HDFC wanted to make the process faster without taking more risks. So, it launched a 10 second paperless instant loan plan for its existing customers – salaried employees - whose details(earnings & spending patterns) it already has (Exhibit 7). Users could simply log into their bank account via net-banking or mobile banking and avail of this loan at a click particularly in medical or other types of emergencies.On the very first day, the bank ended up disbursing personal loans of an average size of Rs 3 lakh in a minute. Apart from attracting more requests for personal loans, it increased the efficiency of loan processing.

Chillr - It’s a mobile app allows users to instantly transfer money to any contact in their phonebook 24 hours a day, seven days a week. HDFC Bank collaborated with MobME, a Kochi-based technology firm, to launch this app (Exhibit 8). It has is linked directly to the customer’s bank account, so there is no need to worry about filling up a prepaid wallet. It allows users to send money in three simple steps:

i. Choose the recipient from your list of Chillr contactsii. Enter the amount to be transferred & a message to recipient

iii. Enter your secret M-PIN & press PAY

Priority Sector Lending

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India’s central bank, Reserve Bank of India has mandated a priority sector-lending target of 40% of total ANBC or CEOBC to help develop the section of society at the bottom of pyramid and where banks would not normally lend. The bank met the overall target of 40% and exceeded it by 6%, however, it has been consistently been not able to meet its sub-targets with the PSL norms. For example, in fiscal 2014, agricultural loans made under the ‘direct’ category were 12.2% of ANBC, against the requirement of 13.5%, with a shortfall of Rs 29.03 billion, and advances to sections termed “weaker” by the RBI were 6.25% against the requirement of 10.0%, with a shortfall of Rs 83.97 billion.

In the case of non-achievement of priority sector lending targets, including sub-targets, it is required to invest in deposits of Indian development banks, such as the National Bank of Agriculture and Rural Development, National Housing Bank and the Small Industries Development Bank of India. As of March 31, 2014, total investments as directed by the RBI in such deposits were Rs151.19 billion, yielding returns ranging from 3% to 8.25%. Gross NPAs in the directed lending sector as a percentage to gross loans were 0.3% as of September 30, 2014 (as compared to 0.4% as of March 31, 2014 and March 31, 2013). Further expansion of the PSL scheme could result in an increase of NPAs due to its limited ability to control the portfolio quality under the directed lending requirements.

The profitability of these operations depends on bank’s ability to generate business volumes from such customers. Future changes by the RBI in the directed lending norms may result in bank’s further inability to meet the priority sector lending requirements as well as require it to increase our lending to relatively more risky segments and may result in an increase in non-performing loans.

Future Challenges for the banks

One of the major challenges that banks face are threat from E-wallets. Previously banks faced competition only from similar entities (other banks).But now they are facing competition from online payment systems. In India, more than 500 million people do not have bank accounts but own mobile phones, getting these people on to mobile wallets helps achieve our country’s financial inclusion agenda in a big way. People who do not have an account, or have poor access to banks, can access a mobile wallet for transactions. It is expected that Rs. 1,500-2,000 crore could be transacted on these platforms this year. The major companies providing mobile wallet services in India are telecom service providers such as Vodafone’s m-pesa, Bharti Airtel Ltd’s Airtel Money, Aircel’s Mobile Money and Tata Teleservices Ltd’s mRupee and payment services companies like Oxigen Services, PayTM and MobiKwik. Paytm is developing a system under which you could pay by simply transferring money from your mobile wallet to the retailer’s wallet just like cash. The universal banking license to new players in CY14 will be the game changer for the banking

sector, as it will allow non‐financial non‐banking companies to establish banks, which will increase competition in banking over the medium to long-term scenario. Such competition in

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the industry may decrease the market share of the existing banks. One of the major causes of concern is the payment banking licence given to 11 applicants in 2015, which will eat away into the shares of existing banks. Another issue the bank is facing is its CASA has fallen from 47.4 per cent to 44.8 per cent in the last one year.

Another Cause for Concern is the fulfilment of Basel III norms. In which banks face stricter capital constraints which creates major headwinds for profitability in CY15.Banks will have

to bring in an additional capital of Rs 1.8‐2.0 trillion to meet Basel III norms. Out of this 45‐50% may be issued in the form of Additional Tier I, 35‐40% through Tier II and balance through common equity. Basel III norms have to be implemented in phased manner starting from April 2013 until March 2019. Clearly, sourcing equity capital of this size in the face of fiscal constraints poses significant challenges.

Increase in NPAs is one thing that bank has to keep in control because lot of provision needs to be done for NPAs in different Asset Classes. Lack of significant improvement in economy will lead to increase in NPAs and restructured loans of banks. Infrastructure exposure will remain a key risk especially for PSBs, given the elevated execution challenges leading to project delays. Moreover, the government is planning to infuse 7000 crores in the PSBs in the year 2015-16 in a phased manner. This advantage is not present for the private banks so their income is hurt because of provisions for NPA

Managing Human Resources is not only a problem for banks but also it is a problem worldwide across sectors. Banks will have to incur substantial employee costs as the attrition of the employees in banking industry may increase in CY15 with the entry of new banks.

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ExhibitsExhibit 1

Exhibit 2

Important Financial parameters for past 5 years

2014-15 2013-14 2012-13 2011-12 2010-11Net Profit (Rs in Crores) 10,700.05 8,764.51 6,900.28 5,273.40 4,017.69Total Assets (Rs in Crores) 6,07,168.86 5,03,678.98 4,07,780.56 3,41,116.50 2,78,038.80

Equity 501.3 479.81 475.88 469.34 465.23

ROA 1.76% 1.74% 1.69% 1.55% 1.45%

ROE 21.34 18.27 14.5 11.24 8.64

Networth (Rs in Crores) 62,009.42 43,478.63 36,214.14 29,924.68 25,379.27Market Capitalisation(Rs in Crores) 2,56,376.87 1,79,652.89 1,48,498.35 1,22,040.13 1,08,998.72ROG-Net Worth (%) 42.62 20.06 21.02 17.91 17.92ROG-Market Capitalisation (%) 42.71 20.98 21.68 11.96 23.22

CASA (%) 44 44.8 47.4 48.4 51

Gross Non- 3,438.38 2,989.28 2,334.64 1,999.39 1,694.34

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Performing Assets (Rs. Cr)Net Non-Performing Assets (Rs. Cr) 896.28 820.03 468.95 352.33 296.41% of Net Non-Performing Assets to Net Advance 0.25 0.27 0.2 0.18 0.19

CAR(%) 16.79 16.07 16.8 16.52 16.22Net Interest Income / Total Funds (%) 4.2 4.14 4.28 4.19 4.22Non-Interest Income / Total Funds (%) 1.66 1.78 1.86 1.88 1.73Credit-Deposit(%) 81.71 81.79 80.14 78.06 76.02Source : Moneycontrol

Exhibit 3

Peer Comparison

HDFC BANK

ICICI BANK

AXIS BANK SBI

Net Interest Income / Total Funds (%) 4.2 3.06 3.37 2.86Non-Interest Income / Total Funds (%) 1.66 1.95 1.98 1.18Credit-Deposit(%) 81.71 104.72 84.71 84.47

Gross Non-Performing Assets (Rs. Cr) 3,438.38 15,094.69 4,110.1956,725.34

Net Non-Performing Assets (Rs. Cr) 896.28 6,255.53 1,316.7127,590.58

% of Net Non-Performing Assets to Net Advance 0.25 1.61 0.46 2.12ROA 1.76% 1.56% 1.59% 0.65%ROE 21.34 11.16 15.71 23.46ROG-Market Capitalisation (%) 42.71 27.07 93.6 39.19Source : Moneycontrol

Exhibit 5

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Exhibit 6

HDFC launches co-branded cards with snapdeal

Launch of Start-up Village

Exhibit 7

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HDFC online advertisement

Exhibit 8

HDFC Bank Launches Chillr Mobile Application

Exhibit 8

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Teaching Notes Concepts and terminologies to be addressed through this case

i. CASA – Current Account Savings Accountii. NPA – Non-performing Assets

iii. NIM – Net Interest Marginiv. CAR - Capital Adequacy Ratiov. Basel Norms

vi. NIM – Net interest Margins

Questions to be covered through the case

Q What are the major revenue sources for bank?

The major portion of a bank's profit comes from the fees that it charges for its services and the interest that it earns on its assets. Its major expense is the interest paid on its liabilities.

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Q What compromises the assets and liabilities portion for a bank?

The major assets of a bank are its loans to individuals, businesses, and other organizations and the securities that it holds, while its major liabilities are its deposits and the money that it borrows, either from other banks or by selling commercial paper in the money market.

Q What is the importance of ROE and ROA?

ROA

ROA signifies the amount of profit an organization earns for every rupee of its assets. Assets include things like cash in the bank, accounts receivable, property, equipment, inventory and furniture. ROA is calculated as:

ROA = Annual Net Income

Total Assets

It is a basic test of how effectively a company's management uses investors' money - ROE shows whether management is growing the company's value at an acceptable rate.

ROE = Annual Net Income

Average Shareholders\' Equity

Q. Why both the ROE and ROA should be considered and not one alone?

The major difference between ROE and ROA is financial leverage, or debt. We know that assets = liabilities + shareholders' equity. This equation tells us that if a company carries no debt, its shareholders' equity and its total assets will be the same. It follows then that their ROE and ROA would also be the same. However, if that company takes on financial leverage, ROE would rise above ROA. We know by another formula that: shareholders' equity = assets - liabilities. By taking on debt, a company increases its assets because of the cash that comes in. However, since equity equals assets minus total debt, a company decreases its equity by increasing debt. In other words, when debt increases, equity shrinks, and since equity is the ROE's denominator, ROE, in turn, gets a boost. At the same time, when a company takes on debt, the total assets - the denominator of ROA - increase. Therefore, debt amplifies ROE in relation to ROA.

Also , ROE weighs net income only against owners' equity therefore it doesn't say much about how well a company uses its financing from borrowing and bonds. Such a company may deliver an impressive ROE without actually being more effective at using the shareholders' equity to grow the company. ROA - because its denominator includes both

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debt and equity - can help you see how well a company puts both these forms of financing to use.

Q What is the key takeaway from ROE and ROA analysis?

So, be sure to look at ROA as well as ROE. They are different, but together they provide a clear picture of management's effectiveness. If ROA is sound and debt levels are reasonable, a strong ROE is a solid signal that managers are doing a good job of generating returns from shareholders' investments. ROE is certainly a "hint" that management is giving shareholders more for their money. On the other hand, if ROA is low or the company is carrying a lot of debt, a high ROE can give investors a false impression about the company's fortunes.

Q What is Market Capitalization?

Market capitalization is calculated by multiplying a total company's outstanding shares by the current market price of one share. Market Capitalization is used determine a company's size, as opposed to sales or total asset figures.

Q What is Net Worth?

Net worth is simply the difference between assets and liabilities. It is also known as Bank Capital. The asset portion of a bank's capital includes cash, government securities and interest-earning loans like mortgages, letters of credit and inter-bank loans. The liabilities section of a bank's capital includes loan-loss reserves and any debt it owes.

It is significant as it represents the margin to which creditors are covered i.e. if a bank liquidates its assets how much can be reaped out.

Q What is CASA Ratio?

The CASA ratio shows how much deposit a bank has in the form of current and saving account deposits in the total deposit.

A higher CASA ratio means higher portion of the deposits of the bank has come from current and savings deposit, which is generally a cheaper source of fund. Many banks do not pay interest on the current account deposits and money lying in the savings accounts attracts a mere 4% interest rate. Hence, higher the CASA ratio better is the net interest margin, which means better operating efficiency of the bank.

Net interest margin is difference between total interest income and expenditure and is shown as a percentage of average earning assets. Higher income from CASA will improve the net interest margin as the cost of this fund is relatively lower. For instance, most banks

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lend at over 10%, whereas, the rate of interest that they pay on saving deposit is just 4%. However, actual realization depends on other expenditure, too.

Q. How is CASA different from term and demand deposits?

Current and saving accounts remain operational. Depositors do not need to give prior notice to withdraw money, however, in case of term deposits; the money is locked in for a specific period. If a depositor wishes to withdraw the money before maturity, he may have to pay a fine. Usually, an overdraft facility is available with the current account deposit. Demand deposit gives you the facility to withdraw your money anytime.

Q What is CAR and its significance?

Capital Adequacy Ratio (CAR) or Capital to Risk (Weighted) Assets Ratio (CRAR) is a parameter signifying the financial strength as well as the stability of the banking concern. The ratio is a metric of the bank's capital with respect to its risk-weighted assets.

CAR = Tier 1 Capital + Tier 2 Capital

Assets * Risk Weight

Q What is Non - Interest Income for the bank?

There are two common measures of the income banks generate from sources other than interest: the non-interest income level and the fee income level.

Non-Interest Income is not affected by the economic cycle changes or interest rate changes. Thus, this forms a defensive

Low Non Interest as compared with ICICI and AXIS bank signifies two things. First is to use competitive pricing to increase the market reach and second is opportunity to increase revenue that can be considered in the coming future.

Other QuestionsQ1. What are different challenges that banks are facing?

Q2. What is the Tier I Capital requirement according to Basel III norms?

Q3. What are the priority sector initiatives taken by the bank?

Q4. What are the areas of main focus for HDFC bank?

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