Capital adequacy and financial indicators for profitability in banks

Banks are the backbone of the Indian economy. The health of the economy depends upon the profitability, performance and efficiency of the banks. After the 2008 crisis, BASEL introduced BASEL III norms which focused on stringent rules for Capital Adequacy Ratio (CAR) and Liquidity management. BASEL III introduced the new buffers - capital conservation buffer and countercyclical buffer to prevent the banking sector during any crisis; and the new minimum CAR requirements set including these margins. The key factors that influence the bank's profitability and performance are Profit per Employee (PPE), Cost of Funds (COF), Return on Advances, Wages as a percentage of total expenses, Return on Assets (ROA), Capital Adequacy Ratio (CAR), and the Net NPA ratio. The banks have been divided in India under 5 different heads namely: SBI and its Associates, Nationalized Banks, Public Sector Banks, Private Sector Banks, and Foreign Banks. Data for five years has been considered for the analysis. The growth percentage for the various banks has been studied. The authors have also used step-wise Multiple Regression model as well as Correlation model1 to determine the factors affecting the Return on Assets (ROA) for each of the banking head and see their correlation. Regression test shows that each banking head has a different set of equation affecting their performance. For some banks it is the COF, for some other it is the PPE which does not affect the ROA of the bank. There are some significant high correlations here and there but no one parameter of study has significant correlations between all categories of banks. It is concluded that CAR is a very important benchmark for the Banking industry but we should be cautious not to look at it in isolation from the other factors.