How to analyse a banking stock: NIM, NPA, CASA and capital adequacy explained

Net interest margin: the core profitability driver

Net interest margin (NIM) is the difference between a bank's interest income on loans and the interest it pays on deposits, expressed as a percentage of earning assets. A higher NIM means the bank retains more of every rupee it lends as profit before operating expenses.

Private sector banks in India have historically commanded higher NIMs than public sector banks because they have a better deposit mix, more selective loan books and stronger pricing power in retail segments. A NIM above 3.5 percent is generally considered healthy for a large-cap Indian private bank, though the threshold varies by business model.

NIM is sensitive to the interest rate cycle. When the Reserve Bank of India cuts rates, a bank's lending rates often reprice faster than its term deposit costs, which can compress NIM in the short run. The reverse happens during a rate-hike cycle, benefiting banks with a floating-rate heavy loan book.

Asset quality: gross NPA and net NPA

Non-Performing Assets (NPAs) are loans where the borrower has not paid interest or principal for more than 90 days. Gross NPA is the total stock of such loans as a percentage of the loan book before any provisions. Net NPA is what remains after the bank sets aside a provision (a reserve) against expected losses.

A rising gross NPA ratio signals credit quality deterioration and forces the bank to increase provisions, which directly reduces profit. The provision coverage ratio (the proportion of gross NPA already covered by provisions) shows how much buffer the bank has: a coverage ratio above 70 percent means most potential losses are already absorbed.

Indian banks went through a major NPA cycle after 2015 driven by corporate infrastructure loans. The cleanup forced several public sector banks into losses and led to a significant tightening of lending standards. Investors now watch NPA formation rates (fresh slippages in each quarter) as a leading indicator of whether the cycle is improving or deteriorating.

CASA ratio: the funding cost advantage

The CASA ratio measures the proportion of a bank's total deposits that come from current accounts (which pay zero interest) and savings accounts (which pay low interest, typically 3 to 4 percent in India). A high CASA ratio means the bank funds a large part of its lending at near-zero cost, which structurally supports NIM.

Banks build their CASA franchise by acquiring salary accounts, offering payments and transaction banking services, and running a large branch and ATM network. HDFC Bank and Kotak Mahindra Bank have historically maintained CASA ratios above 40 to 45 percent, giving them a significant funding cost advantage over smaller private banks and public sector banks with weaker retail franchises.

Capital adequacy and return on equity

The Capital Adequacy Ratio (CAR) under Basel III norms measures a bank's capital as a percentage of its risk-weighted assets. RBI requires Indian banks to maintain a minimum CAR of 11.5 percent, with a Common Equity Tier 1 (CET1) buffer of at least 8 percent. Higher capital means more capacity to absorb losses but can also dilute Return on Equity (ROE) if the capital is not deployed productively.

Return on Assets (ROA) and Return on Equity (ROE) are the summary profitability metrics for banks. A ROA above 1.5 percent is considered strong for Indian private banks. ROE depends on both ROA and the leverage (assets divided by equity) the bank deploys, so a well-capitalised bank with modest leverage may show lower ROE than a more aggressively funded one even at the same asset quality.

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