Capital Adequacy:
Capital Adequacy is a measure of a bank’s financial strength, in terms of its ability to withstand operational and abnormal losses. Further considering the regulatory requirement on the minimum capital required to be maintained by banks, CAR also indicates the ability of bank to undertake additional business. Brickwork Ratings examines the adequacy of capital, both present and future, in light of the business and growth plan of the bank, its ability to raise additional capital considering its current Tier 1 and Tier 2 capital adequacy, the extent of government holding in case of PSU banks and also factors the likely change in the quality of assets and the resultant provisioning/ losses and the additional capital required if any.
Size of capital
The size of capital provides financial flexibility for bank and financial institution. It identifies which financing options are available for the entity. The size of capital also impacts the performance of the bank in terms of return on assets, return on capital employed and return on shareholders fund considering the funding mix. All these are also considered during the analysis.
Asset quality
The asset quality measure is an ability to manage credit risk for a bank or financial institution. The asset quality reflects the composition and productivity of the assets. Asset quality has a direct impact on the financial performance of a bank or financial institutions. The asset quality is evaluated by understanding the performance of assets category wise and estimating future performance factoring in the likely distribution of the assets in future. The bank’s experience of loan loss, provisions/ write off, loan recovery rate, ability to reduce NPAs and extent of weak assets are analyzed in this regard.
Management Quality
The quality of the management will determine the success of a bank or financial institution. The performance of a bank is largely dependent on the vision, competence, integrity and risk appetite of the management. The analysis of the quality of a management is based on the experience of the management and their track record in terms of their vision and competence in running the bank. The analysis of the management also factors in their integrity and the overall corporate governance standards in the bank. The risk appetite in terms of the of the bank’s exposure to various categories of asset, adoption of technology and responsiveness to competition and growth strategy impacts the banks performance, thus is considered during the analysis for rating.
Earning Quality
The quality of earnings of a banks or financial institutions determines the ability of the entity to meet debt obligations, the rate of growth of assets, reserves and ultimately the shareholders' value. We analyze the composition of income by separating it into fee based and fund based activities. The quality of earning coupled with the costs impacts the profitability. Brickwork analyzes track record of the profits, profit margins, growth rate of earnings and components of income and expanses of a bank. The quality of earning is also affected by the extent of asset liability mismatch and the resultant volatility in earnings due to changes in the interest rate.
Liquidity / Asset Liability Management
A bank or financial institution has to be sufficiently liquid to meet payment obligations to depositors and creditors. This calls for a sound Asset Liability Management by the bank. Liquidity analysis considers the bank’s ability to meet its obligations and is very critical for a bank to remain a going concern. The absence of liquidity can lead to failure of a bank. Brickwork thoroughly examines the mismatch in tenor of the bank’s asset and liability. It also considers the proportion of liquid assets to total assets along with their deposit renewal rate.
Brickwork identifies the risk of concentration of the funds, bank’s liability structure and future cash flow projections. The extent of deposit, specially the low cost CASA, and the resultant dependence of a bank on market borrowings impact the liquidity and also the profitability of a bank. The liquidity analysis also takes in to consideration the extent of systemic support available to banks from call money market and the regulator.
Technology
The technology deployed in a banks or financial institutions affects its operational efficiency and determines its competitive position in the market. It must be comparable with the industry standards. Brickwork analyses the level of information technology and its integration within the departments of the bank or financial institutions. Brickwork constantly monitors the endeavors of the bank for constant up-gradation of the technology with industry standard and its competitors.
People
The people in a banks or financial institutions are the most valuable resources and the major driving force for successes and failures. The quality of human resources employed by a bank greatly affects its performance. We analyze the recruitment process and training standard of the financial institution, which reflects the quality of the people in the organization. We analyze their ability to guidance and support to operations staff, compensation package as per the industry norms and attrition rate in the financial institution, which reflect the satisfaction among the employees and staff towards their work and organization.
Government Support
In addition to the above, Brickwork also factors in the Government support, for the industry in general and the government owned public sector banks in particular. This is because banks In India acts as a vehicle to fulfill the economic needs, social requirements and obligation of the Government. We thus believe that Government support plays a crucial role in case of banks and is duly factored in by Brickwork in its analysis. Also the extent of ownership also affects the capital raising ability of a PSU bank in the future.
Risk Management & Basel II
A review typically is conducted by Brickwork Analyst of a bank’s system to identify, measure and control risk factors of its operations, and of all attendant risk management strategies.
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