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Which indicator tracks Indian Banking Sector best? Price-Book Ratio?

Summary:
Bhanu Pratap, Ranajoy Guha Neogi and Jibin Jose of RBI in RBI’s Feb-21 Monthly Bulletin: What is an appropriate measure of bank value? This article argues that price-to-book ratio (PBR) of banks may be considered as an alternative measure of bank value to better understand their health and stability in the Indian context. While there are several indicators such as capital adequacy ratios, Z-scores, and profitability, none of them comprehensively capture the viability of the underlying business models of banks. Moreover, such standard indicators often change due to shifts in the regulatory environment without necessarily reflecting a fundamental change in the health of banks. Through credit intermediation, banks generate valuable intangible assets, such as private information on

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Bhanu Pratap, Ranajoy Guha Neogi and Jibin Jose of RBI in RBI’s Feb-21 Monthly Bulletin:

What is an appropriate measure of bank value? This article argues that price-to-book ratio (PBR) of banks may be considered as an alternative measure of bank value to better understand their health and stability in the Indian context.

    • While there are several indicators such as capital adequacy ratios, Z-scores, and profitability, none of them comprehensively capture the viability of the underlying business models of banks. Moreover, such standard indicators often change due to shifts in the regulatory environment without necessarily reflecting a fundamental change in the health of banks.
    • Through credit intermediation, banks generate valuable intangible assets, such as private information on borrowers’ worth and develop long-term banking relationships with them. Since banking business is subject to stringent entry requirements and regulations, incumbent banks have greater access to market profits. These factors contribute to a bank’s franchise value, which can be captured by its price-to-book ratio.
    • The article finds that variations in PBR have linkages with financial and economic cycles. PBR also shares a close correlation with indicators relating to profitability and viability of banks. As it is available on a high-frequency basis, unlike the balance sheet data, PBR of banks promises to be a useful metric for policy purposes.
Amol Agrawal
I am currently pursuing my PhD in economics. I have work-ex of nearly 10 years with most of those years spent figuring economic research in Mumbai’s financial sector.

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