Valuing a Bank

I have always believed that if an economy grows, the banking system has to grow. Or you can say that a prospering banking system implies a prospering economy. The housing burst in the USA, which propelled the world to a slowdown is a testimony to the importance of a prudent banking system. As far as India is concerned, we have world class banks in HDFC and ICICI along with Axis and Yes Bank, which have the potential to be right at the top. But, the major financing to the country comes from the PSU banks, which are not as structured and efficient as the private players mentioned above. As far as the PSU banks are concerned, the picture today is much better than what it was in the begining of the millennium. Reforms from RBI, such as maintaining a 10% CAR(capital adequacy ratio) and maintaining a provision for the NPA's, along with the operational efficiency demonstrated by the PSU's have paved the way for these banks to be the best in the world.

Comparing the SBI of today with the SBI of 2001, makes me believe that there is lot of value that a PSU bank can create for its shareholders. But one should also understand that the risk associated with investing in a bank is very high( the lehman collapse is an example). Financing after all is a very risky business.

To invest in the banking sector, one needs to value the concerned bank. Valuing a bank, is the second most difficult thing to do from an investors perspective(Realty Sector being the most difficult). Just like any other company, a bank can be valued in two ways. Either you adopt a relative valuation technique or you try to calculate the present value of bank based on future earnings.

I am a novice in valuing a bank. I have been researching a lot trying to figure out an apt way to value a bank and I should say that it is not an easy job. As I progress, I will share all my learning's. For starters, I found the link below very useful

Banks: Look before you leap

I will also try to value the prospective winners in the Indian banking sector and share the findings here. So, watch this space.