Commercial banks have so far been impressing investors by churning out net profits almost every quarter. But how efficiently are they deploying shareholders´ equity to generate returns?

A look at the balance sheets of last several quarters shows that return on shareholder equity, which measures profitability, has remained almost stagnant over the last one year and has fallen drastically compared with that of three years ago.


In the first quarter of the current fiscal year, the average return on equity, or RoE, of 32 commercial banks stood at 17 percent, meaning for every Rs 100 of investors fund a yield of Rs 17 was made. In the fourth quarter of last fiscal year, the average RoE hovered at around the same level. But in the first quarter three years ago, such return stood at 34 percent.

This shows banks were utilizing shareholders equity -- which consists of paid-up capital and earnings or profits retained by institutions -- more efficiently three years ago than at present. This also shows despite posting net profits every passing quarter, banking institutions have not been able to raise the level of profitability.

One of the reasons behind shrinking profitability, in terms of RoE, is growing capital base and expansion of reserve amount, Kishore Maharjan, CEO of Civil Bank, told Republica. In the last three years alone, the number of commercial banks has gone up to 32 from 26.

Along with it, the paid-up capital base of category ´A´ financial institutions has also swollen from Rs 41.83 billion in mid-October 2009 to Rs 71.58 billion by mid-October 2012. In the same period, reserve and surplus amount also surged from a negative of Rs 5.62 billion to Rs 19.95 billion.

But as the capital and retained earnings of commercial banks rose, profits could not rise to the same level, which eroded return on equity of banks, Maharjan said.

If the ground situation remains the same, banks´ profitability will further deteriorate this year as the central bank has recently barred banks from distributing cash dividend if they do not hold capital adequacy ratio of 11 percent, as against 10 percent for normal operation. This means banks won´t be able to extend cash to their shareholders despite posting net profits if they do not have a capital cushion of an extra one percentage point. And this will prevent many from keeping their capital-cum-reserve at super thin level.

One of the ways most of the banks post higher return on equity is by keeping shareholder equity at a minimum level. In other words, banks with little paid-up capital and retained earnings are more likely to post higher return on equity. This is why some of the commercial banks are waiting for Nepal Rastra Bank´s deadline of mid-July 2013 to expire to raise their paid-up capital to Rs 2 billion despite having enough funds in reserve.

Many banks in the US and Europe also followed similar practice prior to the 2008 crisis, until chunk of loans turned bad and ate away the little equity that they had.

An example of this is the Royal Bank of Scotland, the largest British bank at that time, which was generating RoE of around 30 percent from 2000 to 2007. The state later had to bail it out and the bank is now more than 50 percent owned by the British government.

Prior to the crisis many Western banks also resorted to borrowing, a component which is not factored in while calculating RoE. Balance sheets show, Nepali banks have made improvement in this regard as they have reduced their borrowing from Rs 34.37 billion in January 2010 to Rs 11.99 billion in the first quarter this fiscal year.

Top 5 banks in terms of RoE

Nabil Bank - 35.25%

Everest Bank - 32.62%

Standard Chartered Bank Nepal - 29.80%

Nepal Investment Bank - 29%

NCC Bank - 23.72%

Source: Republica