Banks are a large share of every Indian index and are analysed wrongly more often than any other sector. The tools you have learned mostly do not apply — and the ones that do work in a specific, unfamiliar combination.
Why P/E fails
The core framework
- ROE
- Sustainable return on equity through a cycle, not one good year
- Cost of equity
- What you require for taking bank risk — typically 12–14% in India
- The intuition
- A bank earning more than its cost of equity deserves to trade above book; one earning less deserves to trade below
Example: A bank sustainably earning 17% ROE against a 13% cost of equity should trade at a meaningful premium to book. One earning 8% should trade at a discount — and consistently does. The market is not being harsh; it is pricing the arithmetic.
Asset quality: the number that overrides everything
| Metric | What it measures | What to want |
|---|---|---|
| GNPA | Gross bad loans as a share of the book | Below 2% is healthy; above 6% is a crisis |
| NNPA | Bad loans net of provisions already made | Below 1%. The gap to GNPA shows how much is already recognised |
| Provision coverage | Provisions held against bad loans | Above 70% means losses are largely already taken |
| Slippage ratio | Fresh bad loans this year as a share of the book | The forward-looking one. GNPA is history; slippage is what is happening now |
| Credit cost | Provisions as a share of the loan book | Stable and low. A spike consumes the entire operating profit |
What actually compounds
A bank’s intrinsic value grows roughly at the rate its book value per share grows, which is ROE minus whatever is paid out. A bank sustainably earning 16% and retaining most of it compounds book value in the mid-teens — and the share price follows book value over long periods far more closely than it follows any single year’s earnings.
Bank analysis
2 questions. Answers are revealed once you submit all of them.
1.Bank A: ROE 17%, P/B 3.4×, GNPA 1.2%. Bank B: ROE 8%, P/B 0.7×, GNPA 5.8%. Which is better value?
2.Why is slippage more useful than GNPA when assessing a bank today?
Aam dukaan ka maal godown mein hota hai; bank ka "maal" woh loan hai jo usne baanta hai. Toh sawaal yeh nahi ki kitna baanta — sawaal yeh hai ki kitna wapas aayega. Isiliye bank mein profit se pehle NPA dekha jaata hai. Udhaar toh sab de dete hain, wasooli asli kaam hai.
- Bank earnings swing on provisioning judgement, so value them on book rather than P/E.
- Justified P/B follows from ROE versus cost of equity — that explains most of the dispersion.
- Read NIM and GNPA together; margin expanding as bad loans rise means yield bought with risk.
- Slippage is forward-looking; GNPA is history.
- A bank’s value compounds at the rate its book value per share grows.
Mark it done to track your progress through the curriculum.
Common questions
Short, direct answers to what people ask about this topic.
- why is P/E not used to value banks
- Because a bank’s reported profit swings on provisioning — the amount set aside against loans that may go bad — and management has genuine discretion over the timing of those provisions. A single year’s earnings can therefore be shaped substantially by a judgement call, which makes the P/E multiple an unstable measure. Book value moves far more slowly, so banks are conventionally valued on price-to-book instead.
- slippage ratio meaning in banking
- The slippage ratio is fresh bad loans recognised during the year expressed as a share of the loan book — the flow of new problems rather than the accumulated stock. It is the forward-looking asset-quality number: a bank can carry high gross NPAs from an old problem that is now resolving, or low gross NPAs while slippage accelerates. Gross NPA tells you where the bank has been; slippage tells you what is happening now.
- the ratio most commonly used to value a bank is
- Price-to-book — the share price divided by book value per share. It is read alongside return on equity, because a bank sustainably earning more than its cost of equity deserves to trade above book and one earning less deserves to trade below it. That single relationship explains most of the valuation gap between high-ROE Indian private banks and public sector banks trading near or below book.
- what is a good GNPA ratio for a bank
- As a working convention among analysts, gross NPAs below roughly 2% of the loan book are treated as healthy and levels above about 6% signal a serious asset-quality problem; there is no regulatory threshold that defines a “good” number. Net NPAs under about 1% and provision coverage above 70% suggest most of the expected loss has already been taken through the profit and loss account. Compare a bank against its own history and its peer group rather than against a fixed figure.
- difference between gross NPA and net NPA
- Gross NPA is the total value of loans classified as non-performing, usually shown as a share of the loan book; net NPA is that same figure after deducting the provisions already made against those loans. The gap between the two shows how much of the expected loss the bank has already recognised, which is what the provision coverage ratio measures directly. A wide gap means a large part of the damage is still to come through future profits.