As a small-cap finance stock with a market capitalisation of ₹190.94B, the risk and profitability of RBL Bank Limited (NSEI:RBLBANK) 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. These reforms target banking regulations and intends to enhance financial institutions’ ability to absorb shocks resulting from economic stress which could expose banks like RBL 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. Low levels of leverage coupled with sufficient liquidity may place RBL Bank in a safe position in the face of adverse headwinds. We can measure this risk exposure by analysing three metrics for leverage and liquidity which I will take you through today. Check out our latest analysis for RBL Bank

Why Does RBLBANK’s Leverage Matter?

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. Though banks are required to have a certain level of buffer to meet its capital requirements, RBL Bank’s leverage level of 11x is very safe and substantially below the maximum limit 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. If the bank needs to firm up its capital cushion, it has ample headroom to increase its debt level without deteriorating its financial position.

How Should We Measure RBLBANK’s Liquidity?

Since loans are relatively illiquid, we should know how much of the bank’s total assets are comprised of these loans. Normally, they should not exceed 70% of total assets, which is consistent with RBL Bank’s state given its ratio of 60.50%. 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.

Does RBLBANK Have Liquidity Mismatch?

RBLBANK profits by lending out its customers’ deposits as loans and charge an interest on the principle. These loans tend to be fixed term which means they cannot be readily realized, yet customer deposits on the liability side must be paid on-demand and in short notice. 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. Relative to the prudent industry loan to deposit level of 90%, RBL Bank’s ratio of over 85.14%is appropriately lower, which places the bank in a relatively safe liquidity position given it has not excessively lent out its deposits and has maintained a suitable level for compliance.

Next Steps:

RBL Bank 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. Its high liquidity and low leverage levels mean the bank is well-positioned to meet its financial obligations in the case of any adverse and unpredictable macro events. We’ve only touched on operational risks for RBLBANK in this article. But as a stock investment, there are other fundamentals you need to understand. I’ve put together three relevant aspects you should further examine:

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

2. Valuation: What is RBLBANK 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 RBLBANK 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.