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As a small-cap bank stock with a market capitalisation of ₹674.23b, Bandhan Bank Limited’s (NSE:BANDHANBNK) risk and profitability are largely determined by the underlying economic growth of the IN regions in which it operates. Given that banks operate by reinvesting deposits in the form of loans, negative economic growth may lower the level of saving deposits and demand for loans, directly affecting those banks’ levels of cash flows. After the Financial Crisis in 2008, a set of reforms called Basel III was created with the purpose of strengthening regulation, risk management and supervision in the banking sector. The Basel III reforms are aimed at banking regulations to improve financial institutions’ ability to absorb shocks caused by economic stress which could expose banks like Bandhan Bank to vulnerabilities. Its financial position may weaken in an adverse macro event such as political instability which is why it is crucial to understand how well the bank manages its risks. Low levels of leverage coupled with sufficient liquidity may place Bandhan 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.
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Is BANDHANBNK’s Leverage Level Appropriate?
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. Bandhan Bank’s leverage level of less than 5x is extremely small, significantly below the appropriate ceiling of 20x. This is due to the fact that Bandhan Bank’s assets are only less than 5 times equity meaning it has maintained a relatively high level of shareholders’ funds. If the bank needs to increase its debt levels to firm up its capital cushion, there is significant headroom to do so without deteriorating its financial position.
What Is BANDHANBNK’s Level of 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, which is consistent with Bandhan Bank’s state given its ratio of 67.1%. This means slightly over half of the bank’s total assets are tied up in the form of illiquid loans, leading to a sensible balance between interest income and liquidity.
Does BANDHANBNK Have Liquidity Mismatch?
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 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 Bandhan Bank’s loan to deposit ratio of 87.7% is within the sensible margin, below than the appropriate maximum of 90%, this level 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.