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As a small-cap finance stock with a market capitalisation of ₹67b, the risk and profitability of DCB Bank Limited (NSE:DCBBANK) are largely tied to the underlying economic growth of the region it operates in IN. Since a bank profits from reinvesting its clients’ deposits in the form of loans, negative economic growth may lower deposit levels and demand for loan, adversely impacting its cash flow. After the GFC, a set of reforms called Basel III was imposed in order to strengthen regulation, supervision and risk management in the banking sector. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like DCB Bank to vulnerabilities. Since its financial standing can unexpectedly decline in the case of an adverse macro event such as political instability, it is important to understand how prudent the bank is at managing its risk levels. Sufficient liquidity and low levels of leverage could place the bank in a safe place in case of unexpected macro headwinds. Today we will be measuring DCB Bank’s financial risk position by looking at three leverage and liquidity metrics.
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Why Does DCBBANK's Leverage Matter?
Banks with low leverage are better positioned to weather adverse headwinds as they have less debt to pay off. A bank’s leverage may be thought of as the level of assets it owns compared to its own shareholders’ equity. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. DCB Bank’s leverage level of less than the suitable maximum level of 20x, at 11.49x, is considered to be very cautious and prudent. With assets 11.49 times equity, the banks has maintained a prudent level of its own fund relative to borrowed fund which places it in a strong position to pay back its debt in times of adverse events. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.
How Should We Measure DCBBANK's Liquidity?
As above-mentioned, loans are quite illiquid so it is important to understand how much of these loans make up the bank’s total assets. Generally, they should make up less than 70% of total assets, consistent with DCB Bank’s case with a ratio of 66%. At this level of loan, the bank has preserved a sensible level between maintaining liquidity and generating interest income from the loan.
What is DCBBANK's Liquidity Discrepancy?
Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. These loans may be fixed term and often cannot be readily realized, conversely, on the liability side, customer deposits must be paid in very short notice and on-demand. The disparity between the immediacy of deposits compared to the illiquid nature of loans puts pressure on the bank’s financial position if an adverse event requires the bank to repay its depositors. Relative to the prudent industry loan to deposit level of 90%, DCB Bank’s ratio of over 83%is appropriately lower, which positions the bank cautiously in terms of liquidity as it has not disproportionately lent out its deposits and has retained an apt level of deposits.