Post-GFC recovery has driven major financial institutions’ return to health, increasing market confidence in these “too-big-to-fail” banks. As a large-cap stock with market capitalization of IN₨2.37T, State Bank of India (NSEI:SBIN) falls into this category. A set of reforms called Basel III was imposed in order to strengthen regulation, supervision and risk management in the banking sector. These reforms target bank level regulation and aims to improve the banking sector’s ability to absorb shocks arising from economic stress which could expose financial institutions to vulnerabilities. SBIN operates predominantly in INR and is held to stringent regulation around the type and level of risk it can take on, exposing it to higher scrutiny on its risk-taking behaviour. Investors should be more cautious when it comes to financial stocks given the different type of risk to which they are exposed. Today we will analyse some bank-specific metrics and take a closer look at leverage and liquidity. See our latest analysis for State Bank of India

Is SBIN’s Leverage Level Appropriate?

Banks with low leverage are exposed to lower risks around their ability to repay debt. A bank’s leverage can be thought of as the amount of assets it holds compared to its own shareholders’ funds. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. State Bank of India’s leverage level of 15x is significantly below the appropriate ceiling of 20x. This means the bank exhibits very strong leverage management and is well-positioned to repay its debtors in the case of any adverse events since it has an appropriately high level of equity relative to the debt it has taken on to remain in business. Should the bank need to increase its debt levels to meet capital requirements, it will have abundant headroom to do so.

What Is SBIN’s Level of Liquidity?

As I eluded to above, loans are relatively illiquid. It’s helpful to understand how much of this illiquid asset makes up the bank’s total asset. Generally, they should make up less than 70% of total assets, consistent with State Bank of India’s case with a ratio of 54.34%. This is a reasonable ratio and suggests that slightly over half of the bank’s total assets are tied up in the form of illiquid loans, striking an appropriate balance between liquidity and interest income.

What is SBIN’s Liquidity Discrepancy?

SBIN profits by lending out its customers’ deposits as loans and charge an interest on the principle. 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 discrepancy between loan assets and deposit liabilities threatens the bank’s financial position. If an adverse event occurs, it may not be well-placed to repay its depositors immediately. Since State Bank of India’s loan to deposit ratio of 69.54%is well-below than the appropriate maximum of 90%, this means the bank is lending out less than its total level of deposits and 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. Given the large headroom for growth in loans, the bank has opportunity to grow its interest income.

Next Steps:

State Bank of India meets all of our liquidity and leverage criteria, exhibiting operational prudency. The operational risk side of a bank is an important fundamental often overlooked by investors. High liquidity and low leverage places the bank in an ideal position to repay financial liabilities in case of adverse headwinds. We’ve only touched on operational risks for SBIN in this article. But as a stock investment, there are other fundamentals you need to understand. Below, I’ve compiled three key aspects you should look at:

• 1. Future Outlook: What are well-informed industry analysts predicting for SBIN’s future growth? Take a look at our free research report of analyst consensus for SBIN’s outlook.

• 2. Valuation: What is SBIN worth today? Has the future growth potential already been factored into the price? The intrinsic value infographic in our free research report helps visualize whether SBIN is currently mispriced by the market.

• 3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.