As a small-cap bank stock with a market capitalisation of ₹205b, Canara Bank’s (NSE:CANBK) 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. Post-GFC recovery brought about a new set of reforms, Basel III, which was created to improve regulation, supervision and risk management in the financial services industry. Basel III target banking regulations to improve the sector’s ability to absorb shocks resulting from economic stress which may expose financial institutions like Canara 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. 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 Canara Bank’s financial risk position by looking at three leverage and liquidity metrics.
Is CANBK’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. Canara Bank’s leverage level of less than the suitable maximum level of 20x, at 16.87x, is considered to be very cautious and prudent. With assets 16.87 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. If the bank needs to increase its debt levels to firm up its capital cushion, there is plenty of headroom to do so without deteriorating its financial position.
What Is CANBK’s Level of Liquidity?Due to its illiquid nature, loans are an important asset class we should learn more about. Generally, they should make up less than 70% of total assets, which is consistent with Canara Bank’s state given its ratio of 61%. 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.
What is CANBK’s Liquidity Discrepancy?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 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 Canara Bank’s loan to deposit ratio of 74% 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.
Canara Bank ticks all the boxes for operational prudency in terms of liquidity and leverage. Investors often sideline these factors compared to other fundamentals, but they are equally important to consider as part of the investment thesis. The bank’s favourable liquidity and leverage position exposes it to less risk when it comes to repaying financial obligations, in particular, in the case of an adverse macro event. Today, we’ve only explored one aspect of Canara Bank. However, as a potential stock investment, there are many more fundamentals you need to consider. I’ve put together three essential factors you should further research:
- Future Outlook: What are well-informed industry analysts predicting for CANBK’s future growth? Take a look at our free research report of analyst consensus for CANBK’s outlook.
- Historical Performance: What has CANBK’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- 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.
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