As a small-cap bank stock with a market capitalisation of ₹44.54B, Andhra Bank’s (NSEI:ANDHRABANK) risk and profitability are largely determined by the underlying economic growth of the IN regions in which it operates. Since banks make money by reinvesting its customers’ deposits in the form of loans, strong economic growth will drive the level of savings deposits and demand for loans, directly impacting the cash flows of those banks. 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 Andhra Bank to vulnerabilities. Unpredictable macro events such as political instability could weaken its financial position which is why it is important to understand how well the bank manages its risk levels. Low levels of leverage coupled with sufficient liquidity may place Andhra 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 Andhra Bank
Why Does ANDHRABANK’s Leverage Matter?
A low level of leverage subjects a bank to less risk and enhances its ability to pay back its debtors. Leverage can be thought of as the amount of assets a bank owns relative to its shareholders’ funds. Financial institutions are required to have a certain level of buffer to meet capital adequacy levels. Andhra Bank’s leverage level of 20x is very safe and substantially below the maximum limit of 20x. This means the bank has a sensibly high level of equity compared to the level of debt it has taken on to maintain operations which places it in a strong position to pay back its debt in unforeseen circumstances. 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 ANDHRABANK’s Liquidity?
Due to its illiquid nature, loans are an important asset class we should learn more about. Usually, they should not be higher than 70% of total assets, consistent with Andhra Bank’s case with a ratio of 60.71%. At this level of loan, the bank has preserved a sensible level between maintaining liquidity and generating interest income from the loan.
Does ANDHRABANK Have Liquidity Mismatch?
Banks operate by lending out its customers’ deposits as loans and charge a higher interest rate. Loans are generally 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 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. Since Andhra Bank’s loan to deposit ratio of 70.02% is within the sensible margin, below than the appropriate maximum of 90%, this level 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.