Branch profitability and a dairy loan versus a G-sec placement
Branch X of a regional rural bank reports the following for the year (amounts in rupees crore): deposits 60.00 at an average cost of 6.00 per cent; advances 52.00 at an average yield of 10.50 per cent; investments 8.00 at an average yield of 7.00 per cent; other income 0.90; operating expenses 2.10; provisions 0.50. Gross NPAs stand at 3.12 and the branch holds no cash surplus. A dairy co-operative seeks a fresh term loan of 5.00 at 10.25 per cent, to be funded entirely by new deposits raised at 6.75 per cent. Incremental operating cost on the loan is estimated at 0.35 per cent of the loan and expected credit cost at 1.40 per cent. The same 5.00 could instead be placed in SLR securities yielding 7.10 per cent. The branch's priority sector shortfall is 4.20, and the dairy loan qualifies as priority sector while the G-sec placement does not.
1. Compute the branch's net interest margin on earning assets, credit-deposit ratio, gross NPA ratio and net profit for the year. Show each step.
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Interest income: advances 52.00 x 10.50% = 5.46; investments 8.00 x 7.00% = 0.56; total 6.02. Interest expense: 60.00 x 6.00% = 3.60. Net interest income = 6.02 - 3.60 = 2.42. Earning assets = advances + investments = 52.00 + 8.00 = 60.00, so NIM = 2.42 / 60.00 = 4.03 per cent. Credit-deposit ratio = 52.00 / 60.00 = 86.67 per cent. Gross NPA ratio = 3.12 / 52.00 = 6.00 per cent. Net profit = NII 2.42 + other income 0.90 - operating expenses 2.10 - provisions 0.50 = 0.72 crore. Read together, the numbers say the branch is profitable but thin: a 6 per cent gross NPA ratio on a 4.03 per cent margin means provisioning absorbs most of the cushion, so every incremental asset must be priced and appraised with care rather than added for volume.
2. Compare the two uses of the 5.00 crore on a like-for-like basis and find the expected credit cost at which the loan stops beating the G-sec placement.
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Loan route, annual figures: interest 5.00 x 10.25% = 0.5125; funding cost 5.00 x 6.75% = 0.3375; operating cost 5.00 x 0.35% = 0.0175; credit cost 5.00 x 1.40% = 0.0700. Net = 0.5125 - 0.3375 - 0.0175 - 0.0700 = 0.0875 crore, or 8.75 lakh. G-sec route: income 5.00 x 7.10% = 0.3550; funding cost unchanged at 0.3375; net = 0.0175 crore, or 1.75 lakh, with no credit cost but also no priority sector credit. Break-even: 0.5125 - 0.3375 - 0.0175 - x = 0.0175 gives x = 0.1400, i.e. expected credit cost of 2.80 per cent of the loan. Below that, the loan earns more; above it, the G-sec wins on income even before counting the priority sector shortfall. The margin of safety is the 1.40 percentage point gap between assumed and break-even credit cost, not the headline 10.25 per cent rate.
3. Would you sanction the loan? State your recommendation and the two checks that could reverse it.
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Recommendation: sanction in principle, conditional on documented checks, because the loan contributes about five times the net income of the G-sec route (8.75 lakh against 1.75 lakh), reduces the 4.20 crore priority sector shortfall to nil with 0.80 crore to spare, and the break-even credit cost of 2.80 per cent leaves room above the 1.40 per cent assumption. First check that can reverse it: the funding assumption. If the 5.00 crore of new deposits must carry cash reserve and SLR obligations, only about 78 per cent is deployable; funding 5.00 of loan would then need roughly 6.40 of deposits, lifting the effective funding cost to about 8.65 per cent and turning the incremental spread negative. The branch must confirm the deposit is genuinely incremental and that its overall reserve position absorbs the leakage, otherwise the loan should be re-priced or trimmed. Second check: exposure and appraisal - single-borrower and group exposure ceilings, the co-operative's milk supply contract and repayment source, and security. A 6 per cent existing gross NPA ratio argues for conditions, not for volume.