Understated Factors To Consider Before Investing In IndusInd Bank Limited (NSE:INDUSINDBK)

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As a large-cap stock with market capitalization of ₹882b, IndusInd Bank Limited (NSE:INDUSINDBK) is classified as a major bank. As these large financial institutions revert back to health after the Global Financial Crisis, we are seeing an increase in market confidence, and understanding of, these “too-big-to-fail” banking stocks. After the crisis, 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 to vulnerabilities. As a large bank in INR, INDUSINDBK is exposed to strict regulation which has focused investor attention on the type and level of risks it is subjected to, and 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.

Check out our latest analysis for IndusInd Bank

Is INDUSINDBK'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. While financial companies will always have some leverage for a sufficient capital buffer, IndusInd Bank’s leverage ratio of 9.3x is very safe and substantially below the maximum limit of 20x. With assets 9.3 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. 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 INDUSINDBK's 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 IndusInd Bank’s case with a ratio of 65%. 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 INDUSINDBK's Liquidity Discrepancy?

A way banks make money is by lending out its deposits as loans. These loans may be fixed term and often 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. Compared to the appropriate industry loan to deposit level of 90%, IndusInd Bank’s ratio of over 96% is higher which puts the bank in a risky position as it borders negative liquidity disparity between loan and deposit levels. Basically, for ₹1 of deposits with the bank, it lends out over ₹0.9 which is imprudent.

Next Steps:

The bank’s liquidity and leverage ratios suggest its sensible operational risk management. This means it is well-placed to meet its financial obligations in the case of any adverse and unpredictable macro events. We've only touched on operational risks for INDUSINDBK in this article. But as a stock investment, there are other fundamentals you need to understand. I've put together three important factors you should further research:

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

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.