1

2

PREFACE

This report explains the concept of Economic Value Added that is

gaining popularity in India, found by the Stern & Stewart co. which can

be used by bankers to measure the financial performance of their bank.

The report studies Indian bank’s profile to demonstrate a direct

correlation between the investment in stakeholder relationships and

corporate performance. Many Indian banking seems to have destroyed

shareholder’s wealth over a period of time and only a few have

positively contributed to their wealth. With the help of EVA (Economic

Value Added) which tell what the institution is doing with investor’s hard

earned money, the report examines an appropriate way of evaluating

bank’s performance and also finds out which Indian banks have been

able to create (or destroy) shareholders wealth since 2003-2004 to

2007-2008.

The overriding message of this report is that banks must always

strive to maximize shareholders value without which their stocks can

never be fancied by the market. This analysis helps us to dig below the

surface numbers to tell us more about the underlying business and

whether there is a prima facie case for using EVA as one of the range of

performance measurement tools.

3

ACKNOWLEDGEMENT

On the eve of completion and submission of grand project we

would like to express our deep sense of gratitude to our Management

Institute and Gujarat University for providing us Platform of

management studies.

We are immensely thankful to our guide Mr. S. O. Junare

(Director of MBA Department) for providing us great insight into the

project and for sparing his valuable time with us. Without his co-

operation it was impossible to reach up to this stage. We also thankful

to Faculty members for their moral support during the project.

We humbly express our feelings and heartily thank Altaf Kabra and

Bankim Soni who have helped us in one or the other way during the

completion of this report.

At last, our sincere regards to our parents and friends who have

directly or indirectly helped us in the project. Without their inspiration

and support we would not have been where we are.

4

DECLARATION

We, Jay Mehta and Uday Bhavsar, the students of MBA-II declare

that the project titled "A Study On Economic Value Addition By Public

and Private Sector Banks" has been prepared based on the detailed

literature review and the sources benevolent to the study as shown in

the bibliography, remarks, analysis and interpretation in this project to

prove the concept true as per law.

Moreover, we also declare that the said project is not submitted

anywhere else for the award of M.B.A. degree.

Signature:

Signature:

Date:

Place:

5

Table of Contents

• 1.1 Executive Summery

• 1.2 Introduction to Project

Chapter 1 : Grand Project - An Introduction

• 2.1 Research Objectives

• 2.2 Research Methodology

Chapter 2 : Research Design

• 3.1 Overview of SBI, BOB, ICICI Bank and HDFC Bank

Chapter 3 : Overview Of Banking

• 4.1 What is EVA ?

• 4.2 Benefits of EVA for Banks

• 4.3 Limitation of traditional Methods

• 4.4 Performance Measurement

• 4.5 EVA a superior Performancee Measure

Chapter 4 : Introduction to Economic Value Added

• 5.1 Net Operating Profit After Tax

• 5.2 Return On Invested Capital

• 5.3 Cost of Capital

• 5.4 Capital Charge

• 5.5 Economic Value Added

Chapter 5 : Data Analysis & Interpretation

Chapter 6 : Conclusion and Findings

Bibliography

Annexures

6

Grand Project -An Introduction

Chapter 1.

Executive Summery

1.1

Introduction to Project

1.2

7

1.1 Executive Summary

A bank’s management creates value when it takes decisions that

provide benefits, in excess of costs. These benefits may come to banks in

the near or distant future depending on the strategies involved in

decision making process. The bankers of today’s world therefore must

be sensitive to two fundamental drivers that drive shareholders’ wealth.

First, there must be an unrelenting focus to ensure that funds mobilized

by the banks (whether through depositors, equity or debt issues)

generate returns in excess of the cost of capital (or can reasonably be

expected to do so) with an eye toward returning non productive capital

back to providers of the capital or shareholders. Second, bankers should

constantly seek to invest in technology that increases their reach and

also be open to strategic alliances, mergers & acquisitions and

restructuring.

The purpose of report is to examine an appropriate way of

evaluating bank’s performance and also see which Indian banks have

been able to create (or destroy) shareholders wealth since 2005-2006.

To fulfill the purpose of creating shareholders’ value, firstly NOPAT

has to be calculated, our analysis shows that the public sector banks lead

the private banks when NOPAT is emphasized where SBI was in the front

spot for each year respectively as it is the leading bank of India

The Cost of Capital useful for identification of Capital charge for

public sector banks gave a clear indication of effectiveness in 2007-08

but had a failure in each of the respective years of 2006-07 and 2005-06

where private sector banks have the higher cost of capital.

8

The another factor is capital charge sustaining the impact that

Private Banks have a greater focus than public sector banks in each year

respectively. As being a private bank, they have to increase their image

in market by giving higher return to their shareholders.

The next area covered under the study was the calculation of EVA

in percentage terms. The EVA in percentage terms was higher for private

banks because the amount of invested capital is low compared to public

sector banks but in 2005-06, Public sector banks had a bit more

effectiveness compared to private banks due to higher NOPAT compared

to private sector banks.

The EVA in rupees terms was followed after the calculation of EVA

in Percentage terms and it was found to be higher for public sector

banks compared to private sector banks in each of the years due to their

invested capital gives higher return to public sector banks so as to

generate a consistent amount of NOPAT.

All the Banks under our analysis have been found economic value

creator for its shareholders throughout 3 years.

Finally, we met with a successful completion of our Grand Project

Report emphasizing the various concerns of EVA which did help us to

entertain a variety of interpretations and categories of business

etiquettes and compliances.

9

1.2 Introduction to Project

Indian Banking has seen many changes in the last decade like

imposition of prudential standards, greater competition among banks,

entry of new private banks, etc. This paradigm shift in the Indian banking

sector can be seen in terms of two dimensions: One relates to

operational aspect especially performance and risk-management system

and the second dimension relates to structural and external

environment or exogenous aspects. Is evaluating Indian bank’s

performance a rather straight forward issue? The answer is no. One

might say that like a corporate, even banks can be judged from the

behavior of their stock prices. However, as bank stocks have not been

very active on exchanges, barring few on few occasions, should we

conclude that Indian banks have by and large failed to add values to

their shareholders’ wealth. The answer is once again no as one needs to

evaluate private and public sector banks in a more dynamic manner than

just looking at their stock prices, non-performing assets (NPAs), C/D

ratios and others. Some may also argue that the general slowdown in

lending by banks and their eternal problem of recovery of non –

performing assets (NPAs) has led to the sufferings of Indian banks.

Many Indian banks are discovering that the key to their long-term

growth does not lie in products and services alone but in assets that can

never be replicated, that is, their unique relationship with customers,

employees, suppliers and distributors, investors and the communities

they serve. One of the most fateful errors bankers usually commit

relates to their belief that merely reducing NPAs and thereby maximizing

profit would solve “the problem of banking industry”. Not only is this

belief still held by most of the bankers in India - and therefore

10

professionally unacquainted by the changing profile of their

shareholders and the capital market- it is held by virtually large number

of myopic captains of the industry. That things are not going as well as

they ought to be going for such banks could be due to economic

recession, poor demand for credit, rising manpower costs, political

uncertainty, inefficient ways of doing business. Or is it something else?

In order to help management understand their own economics

and arrive at value creating investment decision that adequately satisfies

the two sensitive factors mentioned earlier, bankers must understand

the concept and relevance of “Economic Value Added (EVA)”., a period

based measure of value creation. EVA provides a unique insight into

value creation and links theory of finance with the competitive strategy

framework as enumerated by Michael Porter. EVA is also a quantifiable

driver of value creation for the stock markets. Large number of

International banks (such as Citibank, Deutsche Bank, Barclays, ABN

AMRO) use value based frameworks such as EVA to run their banking

operations. Although EVA an a yardstick in India may be at an evolving

stage, banks like HDFC Bank, ICICI Bank etc. have gradually started

adapting such measure to cater to the increasingly discerning investor

base.

A bank’s management creates value when it takes decisions that

provide benefits, in excess of costs. These benefits may come to banks in

the near or distant future depending on the strategies involved in

decision making process. The bankers of today’s world therefore must

be sensitive to two fundamental drivers that drive shareholders’ wealth.

First, there must be an unrelenting focus to ensure that funds mobilized

by the banks (whether through depositors, equity or debt issues)

generate returns in excess of the cost of capital (or can reasonably be

11

expected to do so) with an eye toward returning non productive capital

back to providers of the capital or shareholders. Second, bankers should

constantly seek to invest in technology that increases their reach and

also be open to strategic alliances, mergers & acquisitions and

restructuring.

In the same context it is worth considering that the capital

mobilized by banks earns a satisfactory return. While it is true that

substantial amount of value creation for a bank or corporate takes place

from less than half of the capital employed, it proves that the entity can

unlock huge amount of capital employed for adding to the value for the

shareholders. The second point mentioned earlier, a necessary corollary

to the first point, emphasizes on the importance of investing in value

creating projects and strategies. It implies criticality of the fact that

bankers must remain sensitive to all such balance sheet items that add

value either through mergers or acquisitions or simply through

restructuring, re-capitalization or any other method such as sell-off of

unproductive assets. Further, bank’s management must be able to

differentiate between projects and strategies. While projects are

generally viewed financially from NPV or IRR point of view, they may not

really convey the fact that whether value is being added to the

shareholders. For example, what distinguishes HDFC Bank, the new

futuristic bank from other savvy banks is its position in the new e-

economy. The “anywhere-anytime” bank is not averse of accepting the

fact that “customer is the king and the bank has to tailor its products as

per his requirements” – even if the new product has a negative NPV as

its alternative strategy of doing nothing may only destroy value for HDFC

Bank. Having established a massive base of customers and holding

extensive information about them, banks such as ICICI Bank and HDFC

12

Bank have already made major head start. They are now all set to

leverage these assets. As we all know the Internet has already started

radically affecting fundamental structures of even Indian banks, not only

in retail operations, but in many other areas including private banking.

The bankers in the new millennium therefore must attempt to make

investment in “strategies” and not merely “remain confined to

borrowing and lending”. They should now play a role of “financial service

providers” for increasing their shareholder’s value.

13

Chapter 2.

Research Design

2.1

Research Objectives

2.2

Research Methodology

14

2.1 Research Objectives

This report aims to study the selected bank’s performance

evaluation and to demonstrate a direct correlation between the

investment in stakeholder relationships and corporate performance.

EVA (Economic Value Added) tells what the institution is doing with

investor’s hard earned money. If we look at the Indian banking industry,

many of them seem to be destroying shareholder’s wealth and only a

few have positively contributed to wealth for its shareholders.

The purpose of report is to examine an appropriate way of

evaluating bank’s performance and also see which Indian banks have

been able to create (or destroy) shareholders wealth since 2005-2006.

The overriding message of this report is that banks must always strive to

maximize shareholders value without which their stocks can never be

fancied by the market. Banks which shrug off this as a trivial matter, they

do so only at their own peril.

To study the shareholders value (in terms of Economic Value Added)

of selected banks during the last three years. I.e. since 2005-06 to

2007-08.

To learn about the business policies and practices of increasing the

value of organization.

To learn EVA and its applications to increase the shareholder’s

wealth.

To measure a bank’s historical success in creating values

To study the determining factors which affects the future

performance of bank’s stock

To examine the excess returns in future and its impact on the value of

the banks.

15

2.2 Research Methodology

Rationale Of The Study

Being Finance Management Students, we have four decisive fields

i.e. Manufacturing, Financial Services, Stock Markets and Banks where

we find opportunity to prepare our grand project.

We have prepared our comparative report on Banking. We have

used EVA tool to measure the economic value of the public and private

sector banks i.e. SBI, BOB, ICICI Bank and HDFC. To acquire the

knowledge of Banking Sector and how their shares perform we have

prepared our report on Banks. By gaining the knowledge of EVA a

measure of economic soundness, we can use it in every fields of finance.

METHODS OF COLLECTION OF DATA

The study is mainly based on secondary data, all the data of four

Indian public and private sector banks i.e. SBI, BOB, ICICI Bank and HDFC

Bank that are listed on the National Stock Exchange are collected from

respective annual reports, publications of RBI and from the various

websites.

TOOLS AND TECHNIQUES OF ANALYSIS

The data from the reports have been analyzed by using various

tools and techniques with a view to evaluate the performance of the

banks. We have calculated following indicators for conducting overall

analysis on 4 banks’ financial performance between 2005-06 to 2007-08.

16

Net Operating profit after Taxes (NOPAT)

(Net Profit + Provisions and contingencies + Interest on Borrowings) less (Taxes)

Incremental NOPAT NOPAT (t) – NOPAT (t-1)

Invested capital Total equity & Reserves + Total borrowings

Incremental Invested capital Invested capital (t) – Invested Capital (t-1)

Return on invested capital (ROIC)

NOPAT / Invested capital

Beta () nxy - (x) (y) nx2 - (x)

2

Cost of Equity (Ke) Rf + ( Rm - Rf )

Cost of Debt (Kd) (Interest Expense - Interest on Deposit) / Total Borrowings

Weighted Average Cost of capital (WACC)

Weighted cost of Equity + Weighted cost of Debt

Economic Value Added (EVA in %)

(ROIC – WACC)

Economic Value Added (EVA in Rs.)

NOPAT - (WACC Invested Capital)

Incremental EVA EVA (t)- EVA (t-1)

LIMITATION OF THE STUDY

The analysis was purely based on the secondary data. So, any

error in the secondary data might also affect the study undertaken.

With regard to the estimation of EVA for banks, one important

difference between financial institution and other firms is the role of

debt. For non banking firms debt forms an integral part of financing

operations and therefore interest expense/income is excluded from

NOPAT calculations so that returns are unlevered. Debt (including

deposits) does off course help finance a bank’s assets but financial

institutions are different at least in two important ways. Deposits are

17

value generating in themselves, or can be, since they usually represent

funding a below market costs (that is it would be incorrect to calculate

the value of whole enterprise and arrive at the value of the equity simply

by excluding the liabilities). A bank’s debt funding is effectively the raw

material which is intermediated (“manufactured”) into high yielding

assets. Interest expense, on this view is the equivalent of the cost of

goods sold.

The above has two consequences.

I. Interest expense on deposit is included in NOPAT and, because of

this,

II. When calculating the cost of capital we define capital as equity &

reserves and borrowings.

18

Chapter 3 Overview

Of Banking

SBI

BOB

ICICI

HDFC

19

3.1 Overview Of Banking

The major participants of the Indian financial system are the

commercial banks, the financial institutions (FIs), encompassing term-

lending institutions, investment institutions, specialized financial

institutions and the state-level development banks, Non-Bank Financial

Companies (NBFCs) and other market intermediaries such as the stock

brokers and money-lenders. The commercial banks and certain variants

of NBFCs are among the oldest of the market participants. The FIs, on

the other hand, are relatively new entities in the financial market place.

Bank of Hindustan, set up in 1870, was the earliest Indian Bank.

Banking in India on modern lines started with the establishment of three

presidency banks under Presidency Bank's act 1876 i.e. Bank of Calcutta,

Bank of Bombay and Bank of Madras. In 1921, all presidency banks were

amalgamated to form the Imperial Bank of India. Imperial bank carried

out limited central banking functions also prior to establishment of RBI.

It engaged in all types of commercial banking business except dealing in

foreign exchange.

Reserve Bank of India Act was passed in 1934 & Reserve Bank of

India (RBI) was constituted as an apex bank without major government

ownership. Banking Regulations Act was passed in 1949. This regulation

brought Reserve Bank of India under government control. Under the act,

RBI got wide ranging powers for supervision & control of banks. The Act

also vested licensing powers & the authority to conduct inspections in

RBI.

In 1955, RBI acquired control of the Imperial Bank of India, which

was renamed as State Bank of India. In 1959, SBI took over control of

eight private banks floated in the erstwhile princely states, making them

as its 100% subsidiaries.

RBI was empowered in 1960, to force compulsory merger of weak

banks with the strong ones. The total number of banks was thus reduced

from 566 in 1951 to 85 in 1969. In July 1969, government nationalised

14 banks having deposits of Rs.50 crores & above. In 1980, government

acquired 6 more banks with deposits of more than Rs.200 crores.

20

Nationalisation of banks was to make them play the role of catalytic

agents for economic growth. The Narsimham Committee report

suggested wide ranging reforms for the banking sector in 1992 to

introduce internationally accepted banking practices.

The State Bank of India, the country’s oldest Bank and a premier in

terms of balance sheet size, number of branches, market capitalization

and profits is today going through a momentous phase of Change and

Transformation – the two hundred year old Public sector behemoth is

today stirring out of its Public Sector legacy and moving with an agility to

give the Private and Foreign Banks a run for their money.

The bank is entering into many new businesses with strategic tie

ups – Pension Funds, General Insurance, Custodial Services, Private

Equity, Mobile Banking, Point of Sale Merchant Acquisition, Advisory

Services, structured products etc – each one of these initiatives having a

huge potential for growth.

The Bank is forging ahead with cutting edge technology and

innovative new banking models, to expand its Rural Banking base,

looking at the vast untapped potential in the hinterland and proposes to

cover 100,000 villages in the next two years.

It is also focusing at the top end of the market, on whole sale

banking capabilities to provide India’s growing mid / large Corporate

with a complete array of products and services. It is consolidating its

global treasury operations and entering into structured products and

derivative instruments. Today, the Bank is the largest provider of

infrastructure debt and the largest arranger of external commercial

21

borrowings in the country. It is the only Indian bank to feature in the

Fortune 500 list.

The Bank is changing outdated front and back end processes to

modern customer friendly processes to help improve the total customer

experience. With about 8500 of its own 10000 branches and another

5100 branches of its Associate Banks already networked, today it offers

the largest banking network to the Indian customer. The Bank is also in

the process of providing complete payment solution to its clientele with

its over 8500 ATMs, and other electronic channels such as Internet

banking, debit cards, mobile banking, etc.

Bank of Baroda, a leading banking institution in India, has a wide

range of products for almost every user segment. The Bank has classified

its range of products into six lines of business (Personal, Business,

Corporate, International, Treasury and Rural).

The bank has had a web presence for some time however to tap

the potential of the online medium remained a daunting task. The Bank

also faced several issues regarding management of database that was

being generated through use of the website. Moreover the ability of the

online medium to be used as a marketing vehicle was a territory never

visited. The look & feel lacked human touch and the six lines of business

were lost between excessive irrelevant information. The website failed

to educate the users about the Bank’s impressive international presence

and new age products such as credit cards, debit cards, fund transfers,

etc.

22

Thus a sound overall flow of content to provide the user with

reader-friendly content, centralization of database to eliminate data

replication, a pleasing look and feel of international repute, a human

approach, better functionality of tools and the right exposure to

important areas formed the core objectives of the new proposed

website

Bank of Baroda is the sixth largest bank in India. It has total assets

in excess of Rs. 1.78 lakh crores, or Rs. 1,780 bn., a network of over 2800

branches and offices, and about 1000+ ATMs. Bank of Baroda offers a

wide range of banking products and financial services to corporate and

retail customers through a variety of delivery channels and through its

specialised subsidiaries and affiliates in the areas of investment banking,

credit cards and asset management. Maharajah of Baroda Sir Sayajirao

Gaekwad III founded the bank on July 20, 1908 in the princely state of

Baroda, in Gujarat. The bank, along with 13 other major commercial

banks of India, was nationalised on 19 July 1969, by the Government of

India.

In its international expansion Bank of Baroda followed the Indian

diaspora, and especially that of the Gujaratis. It has significant

international presence with a network of 72 offices in 25 countries, six

subsidiaries, and four representative offices. Among Bank of Baroda's 42

overseas branches are ones in the world’s major financial centers i.e.

New York, London, Dubai, Hong Kong (which it has upgraded recently),

Brussels and Singapore, as well as a number in other countries. The bank

is engaged in retail banking via 17 branches of subsidiaries in Botswana,

Guyana, Kenya, Tanzania, and Uganda. Bank of Baroda also has a joint-

venture bank in Zambia with nine branches.

23

ICICI Bank is India's second-largest bank with total assets of Rs.

3,744.10 billion (US$ 77 billion) at December 31, 2008 and profit after

tax Rs. 30.14 billion for the nine months ended December 31, 2008. The

Bank has a network of 1,416 branches and about 4,644 ATMs in India

and presence in 18 countries. ICICI Bank offers a wide range of banking

products and financial services to corporate and retail customers

through a variety of delivery channels and through its specialized

subsidiaries and affiliates in the areas of investment banking, life and

non-life insurance, venture capital and asset management. The Bank

currently has subsidiaries in the United Kingdom, Russia and Canada,

branches in United States, Singapore, Bahrain, Hong Kong, Sri Lanka,

Qatar and Dubai International Finance Centre and representative offices

in United Arab Emirates, China, South Africa, Bangladesh, Thailand,

Malaysia and Indonesia. Our UK subsidiary has established branches in

Belgium and Germany.

ICICI Bank was originally promoted in 1994 by ICICI Limited, an

Indian financial institution, and was its wholly-owned subsidiary. ICICI's

shareholding in ICICI Bank was reduced to 46% through a public offering

of shares in India in fiscal 1998, an equity offering in the form of ADRs

listed on the NYSE in fiscal 2000, ICICI Bank's acquisition of Bank of

Madura Limited in an all-stock amalgamation in fiscal 2001, and

secondary market sales by ICICI to institutional investors in fiscal 2001

and fiscal 2002. ICICI was formed in 1955 at the initiative of the World

Bank, the Government of India and representatives of Indian industry.

After consideration of various corporate structuring alternatives in

the context of the emerging competitive scenario in the Indian banking

24

industry, and the move towards universal banking, the managements of

ICICI and ICICI Bank formed the view that the merger of ICICI with ICICI

Bank would be the optimal strategic alternative for both entities, and

would create the optimal legal structure for the ICICI group's universal

banking strategy. The merger would enhance value for ICICI

shareholders through the merged entity's access to low-cost deposits,

greater opportunities for earning fee-based income and the ability to

participate in the payments system and provide transaction-banking

services. The merger would enhance value for ICICI Bank shareholders

through a large capital base and scale of operations, seamless access to

ICICI's strong corporate relationships built up over five decades, entry

into new business segments, higher market share in various business

segments, particularly fee-based services, and access to the vast talent

pool of ICICI and its subsidiaries. In October 2001, the Boards of

Directors of ICICI and ICICI Bank approved the merger of ICICI and two of

its wholly-owned retail finance subsidiaries, ICICI Personal Financial

Services Limited and ICICI Capital Services Limited, with ICICI Bank. The

merger was approved by shareholders of ICICI and ICICI Bank in January

2002, by the High Court of Gujarat at Ahmedabad in March 2002, and by

the High Court of Judicature at Mumbai and the Reserve Bank of India in

April 2002. Consequent to the merger, the ICICI group's financing and

banking operations, both wholesale and retail, have been integrated in a

single entity.

The Housing Development Finance Corporation Limited (HDFC)

was amongst the first to receive an 'in principle' approval from the

Reserve Bank of India (RBI) to set up a bank in the private sector, as part

25

of the RBI's liberalisation of the Indian Banking Industry in 1994. The

bank was incorporated in August 1994 in the name of 'HDFC Bank

Limited', with its registered office in Mumbai, India. HDFC Bank

commenced operations as a Scheduled Commercial Bank in January

1995.

HDFC Bank Ltd. is a commercial bank of India, incorporated in

August 1994, after the Reserve Bank of India allowed establishing private

sector banks. The Bank was promoted by the Housing Development

Finance Corporation, a premier housing finance company (set up in

1977) of India. HDFC Bank has 1,500 branches and over 2,890 ATMs, in

530 cities in India, and all branches of the bank are linked on an online

real-time basis. As of September 30, 2008 the bank had total assets of

INR 1006.82 billion.

In 2008 HDFC Bank acquired Centurion Bank of Punjab taking its

total branches to more than 1,000. Though, the official license was given

to Centurion Bank of Punjab branches, to continue working as HDFC

Bank branches, on May 23, 2008

The financial performance during the fiscal year 2007-08 remained

healthy with total net revenues (net interest income plus other income)

increasing by 50.7% to Rs. 7,511.0 crores from Rs.4,984.7 crores in 2006-

07. The revenue growth was driven principally by an increase in net

interest income. Net interest income grew by 50.7% primarily due to

increase in the average Balance sheet size by 39.8% and an increase in

net interest margin from 4.0% to around 4.4%. The key driver in volumes

was growth in advances. Margin expansion was contributed by increase

in yields across all products partially offset by increase in time deposit

costs.

26

Chapter 4 : Introduction to

EVA

4.1 What is EVA ?

4.2 Benefits of EVA for Banks

4.3 Limitation of traditional Methods

4.4 Performance Measurement

4.5 EVA a superior Performancee

Measure

27

4.1 What is EVA ?

EVA is the invention of Stern Stewart & Co., a global consulting

firm, which launched EVA in 1989. EVA is Economic Value Added, a

measure of economic profit. It is calculated as the difference between

the Net Operating Profit After Tax and the opportunity cost of invested

Capital. This opportunity cost is determined by the weighted average

cost of Debt and Equity Capital (“WACC”) and the amount of Capital

employed.

What separates EVA from other performance metrics such as EPS,

EBITDA, and ROIC is that it measures all of the costs of running a

business— operating and

financing. This makes

EVA the soundest

performance metric, and the

one most closely aligned

with the creation of

shareholder value. In fact,

EVA and Net Present Value

arithmetically tie, so companies can be assured that increasing EVA is

always a good thing for its investors—certainly not the case with EPS or

Free Cash Flow. Many even argue that EVA is a better decision tool than

NPV because it captures the period-by-period value creation or

When, EVA is greater than zero, value is

created during the period for the bank

and if EVA is less than zero, value is

destroyed during the period. In order to

create values, ROIC for a bank must be

greater than weighted average cost of

capital

28

destruction of a given firm or investment, and makes it easy to audit

performance against management projections.

Given the usefulness of the measure, many companies have

adopted it as part of a comprehensive management and incentive

system that drives their decision processes. They strive to increase their

EVA by:

Increasing the NOPAT generated by existing Capital

Reducing the WACC

Investing in new projects where the Return exceeds the WACC

Divesting Capital where the Return is below the WACC

Such focus on value creation has served the shareholders of these

companies well.

A bank’s invested capital multiplied by WACC gives the minimum

level of operating profits the bank should generate to satisfy

shareholders. EVA measures how much net operating profit (adjusted

for tax and also called NOPAT) exceeds the capital charge.

Mathematically, EVA can be estimated focusing both on Management of

Capital as well as the Management of Profits.

A bank’s present value should equal its invested capital plus the

present value of future EVA and if the bank’s present value is lower, the

stock is undervalued and vice versa. Value of a bank’s share is also said

to equal the market value of assets and the sum of EVAs of all future

periods discounted back to the present. A bank once it reaches a period

when it no longer earns a return on its incremental investments greater

than its cost of capital, from this period onward no EVA is added or

destroyed from new investments. While competitive forces are likely to

29

drive returns to WACC for Indian banks, the emergence of indifference

vary from bank to bank and is determined by several factors such as

industry structure, a bank’s position in the industry, capital spending for

strategic investments etc.

A bank’s invested capital multiplied by WACC gives the minimum

level of operating profits the bank should generate to satisfy

shareholders. EVA measures how much net operating profit (adjusted

for tax and also called NOPAT) exceeds the capital charge.

Mathematically, EVA can be estimated focusing both on Management of

Capital as well as the Management of Profits.

EVA - (As a measure of Value creation through Management of Profits)

EVA - (As a measure of value creation through Management of Capital)

30

The use of this formula will produce either a positive or negative

EVA number. A positive EVA reflects that the company is increasing its

value to its shareholders, whereas a negative EVA reflects that it is

diminishing its value to its

shareholders. EVA is

based on the principle

that since a company’s

management employs

equity capital to earn a

profit, it must pay for the

use of this equity capital.

Including a cost for the use

of equity capital sets EVA

apart from more popular

measures of bank performance, such as return on assets (ROA), return

on equity (ROE) and the efficiency ratio, which do not consider the cost

of equity capital employed. As a result, these measures may suggest a

bank is performing well, when in fact it may be diminishing its value to

its shareholders.

“Until a business returns a profit

that is greater than its cost of

capital, it operates at a loss... The

enterprise still returns less to the

economy than it devours in

resources…Until then it does not

create wealth; it destroys it”

- Peter Drucker

31

4.2 Benefits of EVA System for Banks

As banks become ‘capital hungry’ to meet their growth

expectations and simultaneously meeting the regulatory requirements in

the Basel-II era, they would have to remain responsive to the

expectations of the market on a risk adjusted basis to ensure continued

supply of financial capital from the shareholders and human capital from

the ultimate stakeholders.

One of the fundamental limitations in the existing business growth

strategies of Indian banks, especially public sector banks, is its virtual, if

not complete, disconnect with riskiness. ‘Profit rich but Risk poor’

strategies are doomed for failure in the long-run!

Finalization of business targets should no longer remain a

mundane ‘volume-mix’ targeting exercise but should built-in inherent

risk-return dimensions. Business strategies that ensure ‘Risk & Return by

Choice and not by Chance’ are key to ensure continuing success of banks

in the emerging market.

In order to align the performance of individual

zones/regions/branches to the overall corporate expectations in terms

of EVA, the vocabulary of risk management has to percolate down the

hierarchy of banks to the individual unit level. New performance

benchmarks in the form of EVA should naturally form the unifying

cord/link in every bank.

EVA can be an important tool that bankers can use to measure

and improve the financial performance of their bank. Since EVA takes

the interest of the bank’s shareholders into consideration, the use of

32

EVA by bank management may lead to different decisions than if

management relied solely on other measures.

As mentioned earlier an important difference between banks and

others is the role of debt. For other firms debt is a part of the financing

operations and interest expenses are excluded from Net Operating Profit

After Taxes (NOPAT) so that returns are unlevered. A bank’s debt

funding is effectively the raw material which is intermediated into higher

yielding assets. Interest expense, on this view, is equivalent of the cost

of goods sold. This has an important consequence. In our analysis

NOPAT for each year was therefore arrived at after adding interest on

RBI loans and other loans to Profit before Depreciation and Taxes less

Cash Taxes. The component of cash taxes represented as if banks were

debt free. In order to calculate cash taxes, tax shield on the interest paid

on RBI loans and others were added back to Tax Provision and tax paid

on other incomes were deducted from tax provision of the year. A tax

rate of 30 percent per year was assumed for maintaining consistency

over years in our analysis.

The economic capital of a bank is defined as the shareholders

funds plus reserves excluded from equity, such as loan losses or

contingency reserve which in economic terms, function as capital. In this

fund total long term borrowings of the bank are added to arrive at the

Invested Capital (IC). In our analysis we have first attempted to critically

evaluate bank’s performance in generating Return on Invested Capital

(ROIC) over years, we have taken two most critical indicators viz. Return

on Invested Capital (ROIC) and Incremental ROIC.

33

4.3 Limitations of Traditional Methods

Most of the accounting based measures such as Price: Earnings,

Book Value, Returns on Equity, Return on Net worth etc. fail to provide a

clear understanding of the major variables that drive value, except to

some extent Returns on Invested Capital. These methods are easily

influenced by the smart and perhaps mischievous management through

window dressings. They also do not incorporate risk or time value of

money also and do not help investors understand the intricate process

of value creation. In addition, these traditional measures use, for most

part, historical data to measure current performance. Ideally, one would

like to measure how current decisions will affect the firm’s future

performance.

Unlike accounting measures, Economic Value Added, raises the

issue highlighted in the Nobel Prize work of Franco Modigliani and

Merton Miller: just as debt holders of a bank expect a specific return, the

shareholders of the bank, expect a certain rate of return for taking risk

of investing in the bank.

34

4.4 Performance Measurement

Investors measure overall performance of a bank as a whole to

decide whether to invest in the bank or to continue with the bank or to

exit from it. In order to achieve goal congruence, managers’

compensation is often linked with the performance of the responsibility

centers and also with bank-performance. Therefore selection of the right

measure is critical to the success of a bank. To measure performance of

a bank we need a simple method for correctly measuring value created /

enhanced by it in a given time frame. All the current metrics trade off

between the precision in measuring the value and its cost of

measurement. In other words, each method takes into consideration the

degree of complexities in quantifying the underlying measure. The more

complex is the process, the more is the level of subjectivity and cost in

measuring the performance of the bank.

There is a continuous endeavor to develop a single measure that

captures the overall performance, yet it is easy to calculate. Each metric

of performance claims its superiority over others. Performance of a bank

is usually measured with reference to its past record and the

performance of other banks with comparable risk profile. The various

performance metrics currently in use are based on the returns on

investment generated by the business entity. Therefore to reach a

meaningful conclusion, returns generated by the bank in a particular

year should be compared with returns generated by assets with similar

risk profile (cross sectional analysis). Similarly return on investment for

the current period should be compared with returns generated in past

(time series analysis). A bank creates value only if it is able to generate

35

“The EVA framework takes a look at

the balance sheet, income statement,

and the concept of risk all at the

same time. You want to invest lots

and lots of money in NPV-positive

projects. The more such projects you

invest in, the greater is the premium

of market value over book value.”

-Joel Stern, Chairman and CEO of

Stern Stewart & Co

return higher than its cost of capital. Cost of capital is the weighted

average cost of equity and debt (WACC).

The performance of a bank gets reflected on its valuation by the

capital market. Market valuation reflects investor’s perception about the

current performance of the bank and also their expectation on its future

performance. They build their expectations on the estimated growth of

the bank in terms of return on capital. This results in an incongruence

between current performance and the value of the bank. Even if the

current

performance is better in

relative terms, poor

growth prospects

adversely affects the

value of the bank.

Therefore any metric

of

performance, to be

effective, should be

able to not only capture

the current

performance but also should be able to incorporate the direction and

magnitude of future growth. Therefore the robustness of a measure is

borne out by the degree of correlation the particular metric has with

respect to the market valuation.

Metrics of performance have a very important and critical role not

only in evaluating the current performance of a bank but also in

achieving high performance and growth in the future. The metrics of

performance have a variety of users, which include all the stakeholders

36

whose well being depends on the continued well being of the bank.

Principal stakeholders are the equity holders, debt holders,

management, and suppliers of material and services, employees and the

end-users of the products and services. Value creation and maximization

depends on the alignment of the various conflicting interests of these

stakeholders towards a common goal. This means maximization of the

bank value without jeopardizing the interests of any of the stakeholders.

Any metric, which measures the bank value without being biased

towards any of the stakeholders or particular class of participants, can

be hailed as the true metric of performance. However it is difficult, if not

impossible, to develop such a metric. Most of the conventional

performance measures directly relate to the current net income of a

business entity with equity, total assets, net sales or similar surrogates of

inputs or outputs. Examples of such measures are return on equity

(ROE), return on assets (ROA) and operating profit margin. Each of these

indices measure a different aspect of performance, ROE measures the

performance from the perspective of the equity holders, ROA measures

the asset productivity and operating profit margin reflects the margin

realized by the bank at the market place. The net income figure in itself

is dependent on the operational efficiency, financial leverage and the

ability of the entity to formulate right strategy to earn adequate margin

in the market place.

It is important to note that none of these measures truly reflect

the complete picture by themselves but have to be seen in conjunction

with other metrics. These measures are also plagued by the bank level

inconsistencies in the accounting figures as well as the inconsistencies in

the valuation methods used by accountants in measuring assets,

liabilities and income of the bank. Accounting valuation methods are in

37

variance with the methods that are being used to value individual

projects and banks. The value of an asset or a bank, which is a collection

of assets, is computed by discounting future stream of cash flows. The

net present value (NPV) is the surplus that the investment is expected to

generate over the cost of capital. Measures of periodical performance of

a bank, which is the collection of assets in place, should follow the same

underlying principles. Economic value added (EVA) is a measure that

captures the valuation principles.

38

4.5 EVA a Superior Performance Measure

First let us look into the claim of EVA being superior than the

conventional measures such as ROI, ROE and ROA, which are based on

the accounting figures. Most of these measures give us the rate of return

earned by the bank with respect to capital invested in the bank. The

most important limitation of these measures are derived from

limitations inherent in the measurement of accounting profit. As per

current accounting practices, while historical-cost-based accounting

measures are being used to carry most of the assets in the balance

sheet, revenue and expenses (other than depreciation) are recognized in

the profit and loss account at their current value. Therefore accounting

rate of returns do not reflect the true return from an investment and

tend to be biased downwards in the 10 initial years and upwards in the

latter years. Similarly as noted by Malkelainen (Esa Malkelainen 1998),

distortion occurs basically due to the historical cost and straight line

depreciation schedule used by most businesses to value their assets.

This leads to a bias in these measures due to the composition of assets

of a bank at any given point in time. By composition he refers to the

current nature of the assets, more current the assets are, the accounting

rate of return is closer to the true rate of return. This distortion will not

be significant if there is a continuous stream of investments in assets i.e.

the value of the mix of assets is nearer to the current value of the assets.

But the probability, that at any point of time, a bank should have such a

composition of assets is rare, in most cases either the assets are old or

relatively new. This precludes these accounting measures from being

used to reach any meaningful conclusion regarding the true

performance of the bank.

39

The other important limitation of accounting measures is that

they ignore the cost of equity and only consider the borrowing cost. As a

result it ignores the risk inherent in the project and fails to highlight

whether the return is commensurate with the risk of the underlying

assets. This might result in selecting projects that produce attractive rate

of return but destroys bank value because their cost of capital is higher

than the benchmark return established by the management. On the

other hand accounting measures encourage managers to select projects

that will improve the current rate of return and to ignore projects even if

their return is higher than their cost of capital. Selection of projects with

returns higher than the current rate of return does not automatically

increase shareholders’ wealth. Taking up only those projects, which

provide returns that are higher than the hurdle rate (cost of capital)

results in increasing the wealth of the shareholder. Therefore use of

ROE, ROA or similar accounting measures as the benchmark, might

result in selection of those projects that though provide rate of return

higher than the current rate of return destroys bank-value. Similarly use

of these measures result in continuing with activities that destroys bank

value until the rate of return falls below the benchmark rate of return.

EVA proponents claim that because of these imperfections, the

accounting based measures are not good proxies for value creation.

Managerial compensation based on these measures does not encourage

value enhancement actions by managers. Value enhancement and

earnings are two different things and might be at cross-purposes

because short-term performance might be improved at the cost of long

term health of the bank. Activities involving enhancement of current

earnings may be short term in nature, whereas any value enhancing

activities should focus on long term well being of the bank. Avoidance of

40

discretionary costs improves current performance while destroying

value of the bank.

The question arises whether EVA is an improvement over

conventional measures and serves the purpose of motivating managers

to pay attention to shareholders value even if that results in

compromising current performance. The answer may be negative

because all the above limitations are also associated with EVA. As shown

in equation, the calculation of EVA entails the usage of an accounting

rate of return, the difference lies only in the fact that the cost of equity

is also factored in to arrive at the residual income figure. Though

incorporation of the cost of equity capital is the virtue of EVA, because it

measures economic surplus, it does not remove the limitations of the

accounting profit that forms the basis for computing EVA. Moreover the

virtue might not be realized in practice since it is not easy to calculate

the cost of equity. Market returns cannot be used as a proxy for cost of

equity that supports assets in place because market discounts the

expectations. Similarly it is difficult to use CAPM in measuring cost of

equity because it is difficult to measure risk-free-rate of return, beta and

market premium. Difficulties get compounded in an economic

environment like India, where interest rates fluctuate frequently, the

capital market is volatile and the regulators are yet to have a complete

grip on the capital market to enhance its efficiency. Empirical studies

show that the volatility in the Indian capital markets, like capital markets

in other developing economies, is higher than capital markets in

developed economies. Therefore even if for the sake of argument it can

be said that the potential of EVA as a measure of performance can be

realized fully in an advanced economy, the argument that EVA is a better

measure is not tenable in the Indian context.

41

Capital Charge

Cost of Capital

NOPAT

Chapter 5:

Data Analysis

&

Interpretation

42

5.1 Net Operating Profit After Tax

The NOPAT curriculum includes Interest Income, Other Income

deducting interest on deposit and other operating expenses less

tax so as to give an overall emphasis for Operating Profit.

Net Operating Profit is considered instead of Net Profit so as to

highlight the economic value of a firm.

(Net Profit + Provisions and contingencies + Interest on Borrowings)

less (Taxes)

Net Operating Profit

2007-08 2006-07 2005-06

SBI 17,963 13,478 14,058

BOB 3,525 2,856 2,275

ICICI 14,335 10,586 7,650

HDFC 4,269 3,048 2,348

Tax

2007-08 2006-07 2005-06

SBI 5,389 4,043 4,217

BOB 1,058 857 682

ICICI 4,301 3,176 2,295

HDFC 1,281 914 704

NOPAT

2007-08 2006-07 2005-06

SBI 12,574 9,435 9,841

BOB 2,468 1,999 1,592

ICICI 10,035 7,410 5,355

HDFC 2,988 2,134 1,644

2007-08 2006-07 2005-06

SBI 12,574 9,435 9,841

BOB 2,468 1,999 1,592

ICICI 10,035 7,410 5,355

HDFC 2,988 2,134 1,644

12,574

9,435 9,841

2,4681,999 1,592

10,035

7,410

5,355

2,9882,134 1,644

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

43

As per the above tables, the following interpretation has been made.

Comparing all the four esteemed Banks for analysis, we can

prelude that State Bank of India leads the race by holding the highest

Net Operating Profit After Tax of 12574 crores in 2007-08 for both Public

Sector and Private Sector Banks whereas ICICI stood second with 10035

crores in 2007-08in the overall competition but first when Private Sector

Banks were concerned. HDFC stood third in the race with an overall net

operating profit after tax of 2988 crores in 2007-08 keeping BOB at the

last stage with an overall net operating profit after tax of 2468 crores in

2007-08.

Even when years 2006-07 and 2005-06 were taken, same was the

result with State Bank of India holding the top spot in overall context

and ICICI in private sector concerns.

44

Incremental NOPAT

The Incremental NOPAT shows the change in the overall NOPAT in the

year 2007-08 when compared to 2006-07.

NOPAT (t) – NOPAT (t-1)

We can adjudicate that the NOPAT for SBI gave an increment of

3139 crores in 2007-08 with the comparison of its NOPAT of 2006-07

taking SBI at the prime stage of competition. But the case was reverse in

2006-07 when the NOPAT of SBI gave a decrement of -406 crores making

it fell to the 4th slope in the race.

But the remaining three banks have always shown constant

growth in their performances where ICICI bank lead the 2nd spot in 2007-

08 with an incremental NOPAT of 2625 crores and 1st spot in 2006-07

with an incremental NOPAT of 2055 crores. BOB and HDFC have too

shown an immense contribution in the incremental value for the firm.

2007-08 2006-07

SBI 3,139 -406

BOB 469 407

ICICI 2,625 2,055

HDFC 854 490

3,139

-406

469 407

2,625

2,055

854490

-1,000

-500

0

500

1,000

1,500

2,000

2,500

3,000

3,500

45

Invested Capital

The invested capital includes Total Equity and Reserves and borrowings

excluding Total Deposits because these are the prime essentials for

undermining the operations of a business unit.

Total equity & Reserves + Total borrowings

From the above curriculum, we can proclaim that ICICI Bank has made

the highest Capital Investment each time in comparison with other

banks with an investment of 112468 crores in 2007-08, 75919 crores in

2006-07 and 61078 crores in 2005-06.

Whereas SBI holds the second spot, HDFC holds the third spot and

BOB holding the fourth spot in 2007-08. For 2006-07 and 2005-06, SBI

did hold the second spot again with BOB holding the third spot and

HDFC holding the fourth spot each respective year.

2007-08 2006-07 2005-06

SBI 100,760 71,002 58,285

BOB 14,971 9,793 12,646

ICICI 112,468 75,919 61,078

HDFC 15,976 9,248 8,158

100,760

71,00258,285

14,971 9,793 12,646

112,468

75,919

61,078

15,976 9,248 8,1580

20,000

40,000

60,000

80,000

100,000

120,000

46

Incremental Invested Capital

The incremental Invested capital determines the overall change in the

invested capital as compared to the previous year.

Invested capital (t) – Invested Capital (t-1)

Forecasting the above analysis, we can sort out that ICICI bank holds the

key position with an incremental capital glance of 36549 crores in 2007-

08 and 14841 crores in 2006-07 respectively. SBI stood second each time

with an incremental capital glance of 29758 crores and 12717 crores in

2007-08 and 2006-07 respectively. HDFC holds the third position in

2007-08 and 2006-07 respectively. But the performance of BOB

deteriorated drastically in the economy when it suffered a decrement of

-2853 crores in 2006-07 but covered marginally and took it capital

increment base to 5178 crores in 2007-08.

2007-08 2006-07

SBI 29,758 12,717

BOB 5,178 -2,853

ICICI 36,549 14,841

HDFC 6,728 1,090

29,758

12,717

5,178

-2,853

36,549

14,841

6,728 1,090

-5,000

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

47

5.2 Return on invested capital

The return on invested capital signifies the return that the firm earns on

the capital invested for a given period of time.

NOPAT / Invested capital

2007-08 2006-07 2005-06

NOPAT

Capital Employed

NOPAT Capital

Employed NOPAT

Capital Employed

SBI 12,574 100,760 9,435 71,002 9,841 58,285

BOB 2,468 14,971 1,999 9,793 1,592 12,646

ICICI 10,035 112,468 7,410 75,919 5,355 61,078

HDFC 2,988 15,976 2,134 9,248 1,644 8,158

ROIC

2007-08 2006-07 2005-06

SBI 0.12 0.13 0.17

BOB 0.16 0.20 0.13

ICICI 0.09 0.10 0.09

HDFC 0.19 0.23 0.20

2007-08 2006-07 2005-06

SBI 0.12 0.13 0.17

BOB 0.16 0.2 0.13

ICICI 0.09 0.1 0.09

HDFC 0.19 0.23 0.2

0.120.13

0.170.16

0.2

0.13

0.090.1

0.09

0.19

0.23

0.2

0

0.05

0.1

0.15

0.2

0.25

48

HDFC bagged the Highest return each time with a return of 19% in

2007-08, 23% in 2006-07 and 20% in 2005-06. For 2007-08 and 2006-07,

BOB stood at the second spot by receiving annual returns of 16% and

20% respectively leading SBI with annual returns of 12% and 13%

respectively and ICICI bank with 9% and 10% respectively. But the

scenario was bit different in 2005-06 where SBI bagged the second spot

by receiving an annual return of 17%, BOB holding the third spot with

13% return and ICICI with the least return of 9%.

49

Beta ()

Beta can be defined as a risk measuring factor for different capital

allotments. Higher the Beta, higher the risk. Beta here has been

calculated based on stock prices vis a vis NIFTY for each year separately.

nxy - (x) (y) ÷ nx2 - (x)2

2007-08 2006-07 2005-06

SBI 0.91 1.22 1.1

BOB 1.08 0.64 0.93

ICICI 1.15 1.14 1.22

HDFC 0.93 1.22 1.03

0.91

1.22

1.11.08

0.64

0.93

1.15 1.141.22

0.93

1.22

1.03

0

0.2

0.4

0.6

0.8

1

1.2

1.4

50

2007- 2008

NIFTY (X) SBI (Y)

X2 XY

BETA (b)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

Mar 3,821.55

970.17

0.91

Apr 4,087.90 266.35 6.97 1,075.00 104.83 10.81 48.58 75.31

May 4,295.80 207.90 5.09 1,320.60 245.60 22.85 25.86 116.19

Jun 4,318.30 22.50 0.52 1,504.36 183.76 13.91 0.27 7.29

Jul 4,528.85 210.55 4.88 1,601.03 96.67 6.43 23.77 31.33

Aug 4,464.00 -64.85 -1.43 1,573.57 -27.46 -1.72 2.05 2.46

Sep 5,021.35 557.35 12.49 1,929.55 355.98 22.62 155.89 282.45

Oct 5,900.65 879.30 17.51 2,051.76 122.21 6.33 306.64 110.91

Nov 5,762.75 -137.90 -2.34 2,272.61 220.85 10.76 5.46 -25.16

Dec 6,138.60 375.85 6.52 2,331.77 59.16 2.60 42.54 16.98

Jan 5,137.45 -1,001.15 -16.31 2,134.58 -197.19 -8.46 265.99 137.92

Feb 5,223.50 86.05 1.67 2,059.45 -75.13 -3.52 2.81 -5.90

Mar 4,734.50 -489.00 -9.36 1,585.40 -474.05 -23.02 87.64 215.49

26.21

59.61 967.50 965.27

2006- 2007

NIFTY (X) SBI (Y)

X2 X*Y

BETA (b)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

Mar 3,402.55

927.01

1.22

Apr 3,508.10 105.55 3.10 853.17 -73.84 -7.97 9.62 -24.71

May 3,185.30 -322.80 -9.20 823.40 -29.77 -3.49 84.67 32.11

Jun 3,128.20 -57.10 -1.79 709.98 -113.42 -13.77 3.21 24.69

Jul 3,143.20 15.00 0.48 790.47 80.49 11.34 0.23 5.44

Aug 3,413.90 270.70 8.61 908.52 118.05 14.93 74.17 128.62

Sep 3,588.40 174.50 5.11 1,003.54 95.02 10.46 26.13 53.46

Oct 3,744.10 155.70 4.34 1,068.90 65.36 6.51 18.83 28.26

Nov 3,954.50 210.40 5.62 1,284.90 216.00 20.21 31.58 113.56

Dec 3,966.40 11.90 0.30 1,215.19 -69.71 -5.43 0.09 -1.63

Jan 4,082.70 116.30 2.93 1,112.61 -102.58 -8.44 8.60 -24.75

Feb 3,745.30 -337.40 -8.26 1,016.42 -96.19 -8.65 68.30 71.45

Mar 3,821.55 76.25 2.04 970.17 -46.25 -4.55 4.14 -9.26

13.27

11.16 329.57 397.22

2005- 2006

NIFTY (X) SBI (Y)

X2 X*Y

BETA (b)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

Apr 1,902.50

549.5

1.10

May 2,087.55 185.05 9.73 629.93 80.43 14.64 94.61 142.37

Jun 2,220.60 133.05 6.37 652.69 22.76 3.61 40.62 23.03

Jul 2,312.30 91.70 4.13 765.97 113.28 17.36 17.05 71.67

Aug 2,384.65 72.35 3.13 762.19 -3.78 -0.49 9.79 -1.54

Sep 2,601.40 216.75 9.09 898.01 135.82 17.82 82.62 161.97

Oct 2,370.95 -230.45 -8.86 803.15 -94.86 -10.56 78.48 93.58

Nov 2,652.25 281.30 11.86 858.24 55.09 6.86 140.76 81.38

Dec 2,836.55 184.30 6.95 869.25 11.01 1.28 48.29 8.91

Jan 3,001.10 164.55 5.80 848.38 -20.87 -2.40 33.65 -13.93

Feb 3,074.70 73.60 2.45 839.91 -8.47 -1.00 6.01 -2.45

Mar 3,402.55 327.85 10.66 927.01 87.10 10.37 113.70 110.58

61.32

57.48 665.58 675.57

51

2007- 2008

NIFTY (X) BOB (Y)

X2 XY

BETA (b) CLOSING

PRICE CHANGE

(Rs.) CHANGE

(%) CLOSING

PRICE CHANGE

(Rs.) CHANGE

(%)

Mar 3,821.55

204.67

1.08

Apr 4,087.90 266.35 6.97 224.61 19.94 9.74 48.58 67.90

May 4,295.80 207.90 5.09 262.39 37.78 16.82 25.86 85.54

Jun 4,318.30 22.50 0.52 260.09 -2.30 -0.88 0.27 -0.46

Jul 4,528.85 210.55 4.88 288.72 28.63 11.01 23.77 53.67

Aug 4,464.00 -64.85 -1.43 258.89 -29.83 -10.33 2.05 14.79

Sep 5,021.35 557.35 12.49 317.11 58.22 22.49 155.89 280.78

Oct 5,900.65 879.30 17.51 329.14 12.03 3.79 306.64 66.43

Nov 5,762.75 -137.90 -2.34 373.41 44.27 13.45 5.46 -31.43

Dec 6,138.60 375.85 6.52 437.89 64.48 17.27 42.54 112.62

Jan 5,137.45 -1,001.15 -16.31 376.3 -61.59 -14.07 265.99 229.39

Feb 5,223.50 86.05 1.67 348.63 -27.67 -7.35 2.81 -12.32

Mar 4,734.50 -489.00 -9.36 272.84 -75.79 -21.74 87.64 203.51

26.21

40.20 967.50 1,070.44

2006- 2007

NIFTY (X) BOB (Y)

X2 XY

BETA (b) CLOSING

PRICE CHANGE

(Rs.) CHANGE

(%) CLOSING

PRICE CHANGE

(Rs.) CHANGE

(%)

Mar 3,402.55

210.74

0.64

Apr 3,508.10 105.55 3.10 202.56 -8.18 -3.88 9.62 -12.04

May 3,185.30 -322.80 -9.20 215.35 12.79 6.31 84.67 -58.10

Jun 3,128.20 -57.10 -1.79 186.82 -28.53 -13.25 3.21 23.75

Jul 3,143.20 15.00 0.48 208.59 21.77 11.65 0.23 5.59

Aug 3,413.90 270.70 8.61 235.33 26.74 12.82 74.17 110.40

Sep 3,588.40 174.50 5.11 270.66 35.33 15.01 26.13 76.74

Oct 3,744.10 155.70 4.34 261.79 -8.87 -3.28 18.83 -14.22

Nov 3,954.50 210.40 5.62 244.67 -17.12 -6.54 31.58 -36.75

Dec 3,966.40 11.90 0.30 225.2 -19.47 -7.96 0.09 -2.39

Jan 4,082.70 116.30 2.93 234.49 9.29 4.13 8.60 12.10

Feb 3,745.30 -337.40 -8.26 205.73 -28.76 -12.26 68.30 101.36

Mar 3,821.55 76.25 2.04 204.67 -1.06 -0.52 4.14 -1.05

13.27

2.24 329.57 205.38

2005- 2006

NIFTY (X) BOB (Y)

X2 XY

BETA (b) CLOSING

PRICE CHANGE

(Rs.) CHANGE

(%) CLOSING

PRICE CHANGE

(Rs.) CHANGE

(%)

Apr 1,902.50

155.06

0.93

May 2,087.55 185.05 9.73 179.11 24.05 15.51 94.61 150.86

Jun 2,220.60 133.05 6.37 179.75 0.64 0.36 40.62 2.28

Jul 2,312.30 91.70 4.13 235.42 55.67 30.97 17.05 127.89

Aug 2,384.65 72.35 3.13 223.86 -11.56 -4.91 9.79 -15.36

Sep 2,601.40 216.75 9.09 227.6 3.74 1.67 82.62 15.19

Oct 2,370.95 -230.45 -8.86 200.36 -27.24 -11.97 78.48 106.02

Nov 2,652.25 281.30 11.86 210.88 10.52 5.25 140.76 62.29

Dec 2,836.55 184.30 6.95 220.34 9.46 4.49 48.29 31.17

Jan 3,001.10 164.55 5.80 228.33 7.99 3.63 33.65 21.04

Feb 3,074.70 73.60 2.45 203.93 -24.40 -10.69 6.01 -26.21

Mar 3,402.55 327.85 10.66 210.74 6.81 3.34 113.70 35.61

61.32

37.65 665.58 510.78

52

2007- 2008

NIFTY (X) ICICI (Y)

X2 XY

BETA (b)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

Mar 3,821.55

829.02

1.15

Apr 4,087.90 266.35 6.97 841.16 12.14 1.46 48.58 10.21

May 4,295.80 207.90 5.09 892.94 51.78 6.16 25.86 31.31

Jun 4,318.30 22.50 0.52 938.48 45.54 5.10 0.27 2.67

Jul 4,528.85 210.55 4.88 910.98 -27.50 -2.93 23.77 -14.29

Aug 4,464.00 -64.85 -1.43 869.28 -41.70 -4.58 2.05 6.55

Sep 5,021.35 557.35 12.49 1,041.37 172.09 19.80 155.89 247.17

Oct 5,900.65 879.30 17.51 1,242.53 201.16 19.32 306.64 338.26

Nov 5,762.75 -137.90 -2.34 1,154.13 -88.40 -7.11 5.46 16.63

Dec 6,138.60 375.85 6.52 1,213.06 58.93 5.11 42.54 33.30

Jan 5,137.45 -1,001.15 -16.31 1,126.63 -86.43 -7.12 265.99 116.20

Feb 5,223.50 86.05 1.67 1,058.51 -68.12 -6.05 2.81 -10.13

Mar 4,734.50 -489.00 -9.36 755.34 -303.17 -28.64 87.64 268.13

26.21

0.51 967.50 1,046.01

2006- 2007

NIFTY (X) ICICI (Y)

X2 XY

BETA (b)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

Mar 3,402.55

562.53

1.14

Apr 3,508.10 105.55 3.10 540.66 -21.87 -3.89 9.62 -12.06

May 3,185.30 -322.80 -9.20 544.24 3.58 0.66 84.67 -6.09

Jun 3,128.20 -57.10 -1.79 465.93 -78.31 -14.39 3.21 25.79

Jul 3,143.20 15.00 0.48 538.06 72.13 15.48 0.23 7.42

Aug 3,413.90 270.70 8.61 580.42 42.36 7.87 74.17 67.80

Sep 3,588.40 174.50 5.11 679.65 99.23 17.10 26.13 87.39

Oct 3,744.10 155.70 4.34 754.99 75.34 11.09 18.83 48.10

Nov 3,954.50 210.40 5.62 847.58 92.59 12.26 31.58 68.92

Dec 3,966.40 11.90 0.30 866.08 18.50 2.18 0.09 0.66

Jan 4,082.70 116.30 2.93 914.27 48.19 5.56 8.60 16.31

Feb 3,745.30 -337.40 -8.26 805.85 -108.42 -11.86 68.30 98.00

Mar 3,821.55 76.25 2.04 829.02 23.17 2.88 4.14 5.85

13.27

44.95 329.57 408.09

2005- 2006

NIFTY (X) ICICI (Y)

X2 XY

BETA (b)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

Apr 1,902.50

338.15

1.22

May 2,087.55 185.05 9.73 368.31 30.16 8.92 94.61 86.75

Jun 2,220.60 133.05 6.37 399.97 31.66 8.60 40.62 54.79

Jul 2,312.30 91.70 4.13 502.08 102.11 25.53 17.05 105.42

Aug 2,384.65 72.35 3.13 460.1 -41.98 -8.36 9.79 -26.16

Sep 2,601.40 216.75 9.09 574.61 114.51 24.89 82.62 226.22

Oct 2,370.95 -230.45 -8.86 476.15 -98.46 -17.14 78.48 151.79

Nov 2,652.25 281.30 11.86 513.82 37.67 7.91 140.76 93.86

Dec 2,836.55 184.30 6.95 558.71 44.89 8.74 48.29 60.71

Jan 3,001.10 164.55 5.80 581.82 23.11 4.14 33.65 24.00

Feb 3,074.70 73.60 2.45 587.55 5.73 0.98 6.01 2.42

Mar 3,402.55 327.85 10.66 562.53 -25.02 -4.26 113.70 -45.41

61.32

59.95 665.58 734.39

53

2007- 2008

NIFTY (X) HDFC (Y)

X2 XY

BETA (b)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

Mar 3,821.55

942.47

0.93

Apr 4,087.90 266.35 6.97 1,011.61 69.14 7.34 48.58 51.13

May 4,295.80 207.90 5.09 1,141.27 129.66 12.82 25.86 65.18

Jun 4,318.30 22.50 0.52 1,140.42 -0.85 -0.07 0.27 -0.04

Jul 4,528.85 210.55 4.88 1,193.97 53.55 4.70 23.77 22.89

Aug 4,464.00 -64.85 -1.43 1,163.54 -30.43 -2.55 2.05 3.65

Sep 5,021.35 557.35 12.49 1,428.07 264.53 22.73 155.89 283.86

Oct 5,900.65 879.30 17.51 1,657.80 229.73 16.09 306.64 281.70

Nov 5,762.75 -137.90 -2.34 1,708.52 50.72 3.06 5.46 -7.15

Dec 6,138.60 375.85 6.52 1,707.47 -1.05 -0.06 42.54 -0.40

Jan 5,137.45 -1,001.15 -16.31 1,541.44 -166.03 -9.72 265.99 158.59

Feb 5,223.50 86.05 1.67 1,440.80 -100.64 -6.53 2.81 -10.94

Mar 4,734.50 -489.00 -9.36 1,312.71 -128.09 -8.89 87.64 83.23

26.21

38.90 967.50 931.70

2006- 2007

NIFTY (X) HDFC (Y)

X2 XY

BETA (b)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

Mar 3,402.55

759.94

1.22

Apr 3,508.10 105.55 3.10 808.97 49.03 6.45 9.62 20.01

May 3,185.30 -322.80 -9.20 740.92 -68.05 -8.41 84.67 77.40

Jun 3,128.20 -57.10 -1.79 786.21 45.29 6.11 3.21 -10.96

Jul 3,143.20 15.00 0.48 785.27 -0.94 -0.12 0.23 -0.06

Aug 3,413.90 270.70 8.61 841.62 56.35 7.18 74.17 61.80

Sep 3,588.40 174.50 5.11 914.02 72.40 8.60 26.13 43.97

Oct 3,744.10 155.70 4.34 992.3 78.28 8.56 18.83 37.16

Nov 3,954.50 210.40 5.62 1,108.07 115.77 11.67 31.58 65.56

Dec 3,966.40 11.90 0.30 1,054.88 -53.19 -4.80 0.09 -1.44

Jan 4,082.70 116.30 2.93 1,065.40 10.52 1.00 8.60 2.92

Feb 3,745.30 -337.40 -8.26 923.55 -141.85 -13.31 68.30 110.03

Mar 3,821.55 76.25 2.04 942.47 18.92 2.05 4.14 4.17

13.27

24.97 329.57 410.58

2005- 2006

NIFTY (X) HDFC (Y)

X2 XY

BETA (b)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

CLOSING PRICE

CHANGE (Rs.)

CHANGE (%)

Apr 1,902.50

520.74

1.03

May 2,087.55 185.05 9.73 529.58 8.84 1.70 94.61 16.51

Jun 2,220.60 133.05 6.37 624.3 94.72 17.89 40.62 114.00

Jul 2,312.30 91.70 4.13 686.52 62.22 9.97 17.05 41.16

Aug 2,384.65 72.35 3.13 628.42 -58.10 -8.46 9.79 -26.48

Sep 2,601.40 216.75 9.09 672.49 44.07 7.01 82.62 63.74

Oct 2,370.95 -230.45 -8.86 595.44 -77.05 -11.46 78.48 101.50

Nov 2,652.25 281.30 11.86 674.21 78.77 13.23 140.76 156.95

Dec 2,836.55 184.30 6.95 695.65 21.44 3.18 48.29 22.10

Jan 3,001.10 164.55 5.80 748.36 52.71 7.58 33.65 43.96

Feb 3,074.70 73.60 2.45 723.53 -24.83 -3.32 6.01 -8.14

Mar 3,402.55 327.85 10.66 759.94 36.41 5.03 113.70 53.66

61.32

42.34 665.58 578.95

54

For 2007-08, the Beta for ICICI bank was highest stating its risk

parameters of 1.15, BOB at the second stage with a beta of 1.08, HDFC

at the third spot with a beta of 0.93 and SBI with the least risk concerned

beta of 0.91.

For 2006-07, the scenario was bit different. Beta for SBI bank and

HDFC Bank were highest stating their risk parameters of 1.22 for both

the banks respectively, ICICI bank at the second stage with a beta of 1.14

and BOB at the third spot with a beta of 0.64.

For 2005-06, the Beta for ICICI bank was highest stating its risk

parameters of 1.22, SBI at the second stage with a beta of 1.10, HDFC at

the third spot with a beta of 1.03 and BOB with the least risk concerned

beta of 0.93.

55

Cost of Equity (Ke)

It determines the expected rate of return for the investors. We

have calculated the cost of equity for the following banks using CAPM

model and taking inputs such as Rf (365 days T-bills rate –same for each

year i.e. 4.55%), Rm (3 years market monthly return of NIFTY) and .

Rf + ( Rm - Rf )

2007-08 Closing Price Change

Rs. Change

(%)

Mar-07 3,821.55

Apr-07 4,087.90 266.35 6.97

May-07 4,295.80 207.90 5.09

Jun-07 4,318.30 22.50 0.52

Jul-07 4,528.85 210.55 4.88

Aug-07 4,464.00 -64.85 -1.43

Sep-07 5,021.35 557.35 12.49

Oct-07 5,900.65 879.30 17.51

Nov-07 5,762.75 -137.90 -2.34

Dec-07 6,138.60 375.85 6.52

Jan-08 5,137.45 -1,001.15 -16.31

Feb-08 5,223.50 86.05 1.67

Mar-08 4,734.50 -489.00 -9.36

Rm 2.18

Ke (SBI)= Ke (BOB)= Ke (ICICI)= Ke (HDFC)=

6.7 7.11 7.27 6.75

2006-07 Closing Price Change

Rs. Change

(%)

Mar-06 3,402.55

Apr-06 3,508.10 105.55 3.10

May-06 3,185.30 -322.80 -9.20

Jun-06 3,128.20 -57.10 -1.79

Jul-06 3,143.20 15.00 0.48

Aug-06 3,413.90 270.70 8.61

Sep-06 3,588.40 174.50 5.11

Oct-06 3,744.10 155.70 4.34

Nov-06 3,954.50 210.40 5.62

Dec-06 3,966.40 11.90 0.30

Jan-07 4,082.70 116.30 2.93

Feb-07 3,745.30 -337.40 -8.26

Mar-07 3,821.55 76.25 2.04

Rm 1.11

Ke (SBI)= Ke (BOB)= Ke (ICICI)= Ke (HDFC)=

56

8.75 6.75 8.48 8.75

2005-06 Closing Price Change

Rs. Change

(%)

Apr-05 1,902.50

May-05 2,087.55 185.05 9.73

Jun-05 2,220.60 133.05 6.37

Jul-05 2,312.30 91.70 4.13

Aug-05 2,384.65 72.35 3.13

Sep-05 2,601.40 216.75 9.09

Oct-05 2,370.95 -230.45 -8.86

Nov-05 2,652.25 281.30 11.86

Dec-05 2,836.55 184.30 6.95

Jan-06 3,001.10 164.55 5.80

Feb-06 3,074.70 73.60 2.45

Mar-06 3,402.55 327.85 10.66

Rm 5.57

Ke (SBI)= Ke (BOB)= Ke (ICICI)= Ke (HDFC)=

3.42 3.6 3.3 3.49

2007-08 2006-07 2005-06

SBI 0.067 0.0875 0.0342

BOB 0.0711 0.0675 0.036

ICICI 0.0727 0.0848 0.033

HDFC 0.0675 0.0875 0.0349

0.067

0.0875

0.0342

0.07110.0675

0.036

0.07270.0848

0.033

0.0675

0.0875

0.0349

0

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

0.09

0.1

SBI

BOB

ICICI

HDFC

57

In 2007-08, ICICI offered the highest cost of equity to its equity

holders taking the utmost risk in the firm and likewise gained a return of

7.27% leading BOB offering 7.11%, HDFC offering 6.75% and SBI with the

least cost of equity of 6.7%.

Whereas in 2006-07, SBI and HDFC were the frontliners offering

cost of equity at around 8.75% each leading ICICI bank offering 8.48%

and BOB with the least offering of 6.75%.

But the scenario was totally different in 2005-06 when BOB

offered the highest cost of equity with 3.6% leading HDFC offering

3.49%, SBI offering 3.42% and ICICI offering the least return of 3.3%.

The Market return of NIFTY in 2005-06 was comparatively very

high therefore the capital gains is high under such cases compared to

2006-07 and 2007-08. The Cost of equity for 2005-06 was therefore very

low compared to 2006-07 and 2007-08 offering high cost of equity.

58

Cost of Debt (Kd)

It can be defined as the total interest paid divided by the total borrowings by a firm.

(Total Interest Expense - Interest on Deposit) / Total Borrowings

SBI

2007-08 2006-07 2005-06

Interest Paid 4,856 Interest Paid 3,479 Interest Paid 2758

Borrowings 51,727 Borrowings 39,703 Borrowings 30,641

Kd 0.065720419 Kd 0.061344821 Kd 0.063

BOB

2007-08 2006-07 2005-06

Interest Paid 497 Interest Paid 441 Interest Paid 357.88

Borrowings 3,927 Borrowings 1,143 Borrowings 4,802.20

Kd 0.088645084 Kd 0.269879042 Kd 0.052166683

ICICI

2007-08 2006-07 2005-06

Interest Paid 6,374 Interest Paid 4,711 Interest Paid 3,761

Borrowings 65,648 Borrowings 51,256 Borrowings 38,522

Kd 0.067965053 Kd 0.064334978 Kd 0.06833865

HDFC

2007-08 2006-07 2005-06

Interest Paid 504.39 Interest Paid 484.13 Interest Paid 370.07

Borrowings 4,478.86 Borrowings 2,815.39 Borrowings 2,858.48

Kd 0.078830997 Kd 0.12037089 Kd 0.090624738

59

In 2007-08, BOB offered the highest cost of debt leading HDFC having

7.88% under its belt, ICICI offering 6.8% and SBI offering 6.57%.

In 2006-07, BOB had made a huge outflow of cost of debt offering

26.99% because the total borrowings were very low compared to other

players and on the other hand, it paid nominal interest as others did.

HDFC was on the second spot with 12.04% and ICICI and SBI ruled the

third and fourth spot with 6.43% and 6.13% respectively.

In 2005-06, the scenario totally changed when BOB offered the

least cost of debt of 5.22%. HDFC offered the highest cost of debt of

9.06%, ICICI following it with 6.83% and SBI on the third spot with 6.3%.

2007-08 2006-07 2005-06

SBI 0.0657 0.0613 0.063

BOB 0.0886 0.2699 0.0522

ICICI 0.068 0.0643 0.0683

HDFC 0.0788 0.1204 0.0906

0.0657 0.0613 0.063

0.0886

0.2699

0.05220.068

0.0643 0.06830.0788

0.1204

0.0906

0

0.05

0.1

0.15

0.2

0.25

0.3

60

5.3 Cost of Capital (WACC)

The weighted average cost of capital (WACC) is the minimum rate of

return on capital required to compensate debt and equity investors for

bearing risk

Weighted cost of Equity + Weighted cost of Debt

Cost Of Equity Cost Of Debt

2007-08 2006-07 2005-06 2007-08 2006-07 2005-06

SBI 0.0670 0.0875 0.0342 0.0657 0.0613 0.0630

BOB 0.0711 0.0675 0.0360 0.0886 0.2699 0.0522

ICICI 0.0727 0.0848 0.0330 0.0680 0.0643 0.0683

HDFC 0.0675 0.0875 0.0349 0.0788 0.1204 0.0906

Weight Of Equity Weight Of Debt

2007-08 2006-07 2005-06 2007-08 2006-07 2005-06

SBI 0.49 0.44 0.47 0.51 0.56 0.53

BOB 0.74 0.88 0.62 0.26 0.12 0.38

ICICI 0.42 0.32 0.37 0.58 0.68 0.63

HDFC 0.72 0.7 0.65 0.28 0.3 0.35

2007-08 2006-07 2005-06

SBI 0.0663 0.0728 0.0495

BOB 0.0757 0.0918 0.0421

ICICI 0.0700 0.0709 0.0552

HDFC 0.0707 0.0974 0.0544

0.06630.0728

0.0495

0.0757

0.0918

0.0421

0.0700

0.0709

0.0552

0.0707

0.0974

0.0544

0.0000

0.0200

0.0400

0.0600

0.0800

0.1000

0.1200

61

In 2007-08, the WACC for BOB was highest of 7.57% because the

proportion of equity for the firm was very high for the bank as against its

proportion of borrowings. HDFC, ICICI and SBI stood firm on second,

third and fourth spot with 7.07%, 7% and 6.63% respectively.

In 2006-07, the weightage of equity was 88% for BOB as against the

weightage of borrowed funds of 12% bringing its WACC to 9.18%. The

same was 7:3 in case of HDFC bank when concerned bringing its WACC

to 9.74% holding the top spot.

In 2005-06, the WACC was low for each bank compared to future years

as the cost of equity was very low.

62

5.4 Capital Charge

Capital charge is the total cost planned with to the bank to pay

interest and dividend for fulfilling the criterias of equity holders and

debt-borrowers.

Cost Of Capital x Capital Invested

2007-08

WACC Capital Invested Capital Charge

SBI 0.066337 100,760 6,684

BOB 0.07566 14,971 1,133

ICICI 0.069974 112,468 7,870

HDFC 0.070664 15,976 1,129

2006-07

WACC Capital Invested Capital Charge

SBI 0.049464 71,002 3,512

BOB 0.09179 9,793 899

ICICI 0.055239 75,919 4,194

HDFC 0.054395 9,248 503

2005-06

WACC Capital Invested Capital Charge

SBI 0.034328 58,285 2,001

BOB 0.04214 12,646 533

ICICI 0.043724 61,078 2,671

HDFC 0.03612 8,158 295

63

ICICI bank provides the highest amount of capital charge to

investors in each year amounting to Rs. 7870 crores in 2007-08, Rs. 4194

crores in 2006-07 and Rs. 2671 crores in 2005-06 because they had huge

amount of capital investment. SBI gained the second spot providing

capital charge of Rs. 6684 crores in 2007-08, 3512 crores in 2006-07 and

2001 crores in 2005-06. BOB remained third each time leading HDFC

each time.

2007-08 2006-07 2005-06

SBI 6,684 3,512 2,001

BOB 1133 899 533

ICICI 7,870 4,194 2,671

HDFC 1,129 503 295

6,684

3,512

2,0011133 899 533

7,870

4,194

2,671

1,129 503 2950

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

64

5.5 Economic Value Added (in %)

(EVA - As a measure of Value creation through Management of Profits)

This concern is used by the following sequence:-

ROIC which includes NOPAT divided by capital employed minus

WACC which pertains the addition of weighted cost of equity and

weighted cost of debt.

ROIC – WACC

ROIC

WACC

2007-08 2006-07 2005-06

2007-08 2006-07 2005-06

SBI 0.12 0.13 0.17

SBI 0.0663 0.0495 0.0343

BOB 0.16 0.2 0.13

BOB 0.0757 0.0918 0.0421

ICICI 0.09 0.1 0.09

ICICI 0.0700 0.0552 0.0437

HDFC 0.19 0.23 0.2

HDFC 0.0707 0.0544 0.0361

2007-08 2006-07 2005-06

SBI 0.0537 0.0805 0.1357

BOB 0.0843 0.1082 0.0879

ICICI 0.0200 0.0448 0.0463

HDFC 0.1193 0.1756 0.1639

0.0537

0.0805

0.1357

0.0843

0.1082

0.0879

0.0200 0.0448 0.0463

0.1193

0.17560.1639

0.0000

0.0200

0.0400

0.0600

0.0800

0.1000

0.1200

0.1400

0.1600

0.1800

0.2000

65

When the question arises so as to create the economic value,

HDFC bank stands firm at the top spot with 11.93% in 2007-08, 17.56%

in 2006-07 and 16.39% in 2005-06. BOB too gave consistent

performance in 2007-08 and 2006-07 giving the economic value added

of 8.43% and 10.82% with second spot. SBI was steady on the third spot

with 5.37% and 8.05% in 2007-08 and 2006-07 respectively. But showed

excellent performance in 2005-06 holding the second spot with a

brilliant EVA of 13.57%. Instead of excellent capital investment, capital

charge and cost of equity, it failed to give better EVA compared to other

sectors.

66

Economic Value Added (in Rs.)

(EVA - As a measure of value creation through Management of Capital)

This scenario is used by the following consequence:-

NOPAT including net operating profit less tax subtracting capital

charge comprising of cost of capital multiplied by capital employed gives

the title at a substantial exposure.

NOPAT - (WACC x Invested Capital)

NOPAT

Capital Charge

2007-08 2006-07 2005-06

2007-08 2006-07 2005-06

SBI 12,574 9,435 9,841

SBI 6,684 3,512 2,001

BOB 2,468 1,999 1,592

BOB 1133 899 533

ICICI 10,035 7,410 5,355

ICICI 7,870 4,194 2,671

HDFC 2,988 2,134 1,644

HDFC 1,129 503 295

2007-08 2006-07 2005-06

SBI 5,890 5,923 7,840

BOB 1,335 1,100 1,059

ICICI 2,165 3,216 2,684

HDFC 1,859 1,631 1,349

5,890 5,923

7,840

1,335 1,100 1,059

2,165

3,2162,684

1,859 1,631 1,3490

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

67

SBI holds higher size of balance sheet and therefore it is consistent

enough to stand firm and provide higher EVA each time revealing Rs.

5890 crores in 2007-08, 5923 crores in 2006-07 and 7840 crores in 2005-

06 proving it as the top public sector bank in the nation. Whereas ICICI

bank stood at the second place with an EVA of 2165 crores in 2007-08,

3216 crores in 2006-07 and 2684 crores in 2005-06 followed by HDFC in

terms of rupees. Instead it stood in terms of percentage sequence, but

failed to secure the position due to the poor size of capital. Though BOB

stood at the last spot, it did provide firm amount of Economic value.

68

Incremental EVA (in Rs.)

The incremental EVA determines the overall change in the EVA as

compared to the previous year.

EVA (t)- EVA (t-1)

While comparing the EVA parameter with that of its previous year,

we proclaimed that SBI lacked the consistency and gave a decrement of -

33 crores in 2007-08 somehow covering the huge decrement of -1917

crores as of 2006-07. But ICICI failed drastically from a superb

Incremental EVA of 532 crores in 2006-07 to a poor decrement of -1051

crores in 2007-08 which was the worst performance by any bank in

2007-08. BOB gave the most consistent Incremental EVA standing firm in

2007-08 and giving an increment of 235 crores crossing its mark of 41

crores’ incremental EVA of 2006-07. HDFC too gave beneficial

Increments to its EVA each time with 228 crores in 2007-08 and 282

crores in 2006-07.

2007-08 2006-07

SBI -33 -1,917

BOB 235 41

ICICI -1,051 532

HDFC 228 282

-33

-1,917

235 41

-1,051

532228 282

-2500

-2000

-1500

-1000

-500

0

500

1000

69

Conclusion

Findings

Chapter 6

70

Conclusion

Banking industry in India is undergoing a rapid metamorphosis.

Their role of a traditional banker has been replaced with financial

services provider for the clients. Most of the PSU and private sector

banks in our country have already started looking at their portfolio of

services offered and what they should do in the future for remaining

competitive in the industry. As public sector banks are likely to undergo

major consolidation, suddenly for many Indian banks things have

changed. The following factors of interpretation serve the purpose of

analyzing the overall concern of proving the study.

The public sector banks lead the private banks when NOPAT is

emphasized in terms of the analysis where SBI was in the front spot for

each year respectively as it is the leading bank of India.

The capital charge factor determines the impact that Private

Banks have a greater focus than public sector banks in each year

respectively. As being a private bank, they have to increase their image

in market by giving higher return to their shareholders.

ROIC gave an equal importance to both the sectors concerned

including public sector and private sector in 2007-08 and 2006-07

2007-08 2006-07 2005-06

PUBLIC BANKS 15,042 11,434 11,433

PRIVATE BANKS 13,023 9,544 6,999

NOPAT

2007-08 2006-07 2005-06

PUBLIC BANKS 7,817 4,411 2,534

PRIVATE BANKS 8,999 4,697 2,966

Capital Charge

2007-08 2006-07 2005-06

PUBLIC BANKS 0.14 0.165 0.15

PRIVATE BANKS 0.14 0.165 0.145

ROIC

71

respectively, but 2005-06 predicted that public sector were more

effective than private sectors by a small margin.

WACC for public sector banks gave a clear indication of

effectiveness in 2007-08 but had a failure in each of the respective years

of 2006-07 and 2005-06 where private sector banks did lead the game.

The EVA in percentage terms was higher for private banks because

the amount of invested capital is low compared to public sector banks

but in 2005-06, Public sector banks had a bit more effectiveness

compared to private banks due to higher NOPAT compared to private

sector banks.

The EVA in rupees terms was higher for public sector banks

compared to private sector banks in each of the years due to their

invested capital gives higher return to public sector banks so as to

generate a consistent amount of NOPAT.

2007-08 2006-07 2005-06

PUBLIC BANKS 0.0710 0.0823 0.0458

PRIVATE BANKS 0.0703 0.0841 0.0548

WACC

2007-08 2006-07 2005-06

PUBLIC BANKS 0.0690 0.0944 0.1118

PRIVATE BANKS 0.0697 0.1102 0.1051

EVA (%)

2007-08 2006-07 2005-06

PUBLIC BANKS 7225 7023 8899

PRIVATE BANKS 4024 4847 4033

EVA (Rs.)

72

Findings

After the detailed analysis of financial data and qualitative

information of the selected banks, we have derived the following

findings,

We found during our analysis that In Public Sector SBI ruled the

market in terms of creating shareholders value in terms of amount

where in the Private Sector HDFC was at the top spot in terms of

percentage.

We found that after bearing all the expenditures including firms’

return to all stakeholders, the remaining wealth i.e. EVA is

accumulated by the shareholders after being reinvested so as to

create an increment in its wealth resources.

As the result of our analysis we found that all the selected Banks

have been creating an EVA and value addition for its shareholders

throughout 3 years.

We found that all banks are creating shareholders’ value in terms

of capital gain as well as reinvestment of the remaining profit into

the business which will surely influence the stock prices in future.

It was found that the reinvestment criteria and its impact will be a

great deal for the firm’s expected success and value creations for

the firm in the mere future.

73

Bibliography

Books:

Frank K. Reilly, Keith C. Brown; Investment Analysis & Portfolio Management; 7th Edition, P. 175.

Prasanna Chandra; Financial management; 7th Edition, P. 828 Robert Anthony and Govindrajan; Management Control System; 11th Edition, P. 299

V.K.Bhalla; Investment Management; 11th Edition, P. 624 William F. Sharpe, Godron J. Alexander, Jeffery V. Bailey; Investments; Fifth Edition, P. 261. Websites: http://en.wikipedia.org/wiki/economic_value_added

http://in.finance.yahoo.com/

http://investopedia.com/university/eva

http://rbidocs.rbi.org.in/rdocs/Publications/DOCs/87122.xls

http://seminars.sternstewart.com/articles.asp

http://seminars.sternstewart.com/whatiseva.html

http://www.banknetindia.com/banking/boverview.htm

http://www.bankofbaroda.com/

http://www.hdfcbank.com/

http://www.icicibank.com/

http://www.rbi.org.in

http://www.statebankofindia.com/

74

Annexures

State Bank of India

Particular 2005-06 2006-07 2007-08

No. of offices 9384 9632 10369

No. of employees 198774 185388 179205

Business per employee (in Rs. lakh) 299.23 357.00 456.00

Profit per employee (in Rs. lakh) 2.17 2.37 3.73

Capital and reserves & surplus 27644 31299 49033

Deposits 380046 435521 537404

Borrowings 30641 39703.34 51727.41

Investments 162534 149149 189501

Advances 261801 337336 416768

Interest income 35980 37242 48950

Other income 7435 6765 8695

Interest expended 20390 22184 31929

Operating expenses 11725 11824 12609

Cost of Funds (CoF) 4.88 4.55 5.64

Return on advances adjusted to CoF 2.74 3.74 3.70

Wages as % to total expenses 25.29 23.33 17.48

Return on Assets 0.89 0.84 1.01

CRAR 11.88 12.34 12.64

Net NPA ratio 1.88 1.56 1.78

(Source: http://rbidocs.rbi.org.in/rdocs/Publications/DOCs/87122.xls)

75

Bank Of Baroda

Particular 2005-06 2006-07 2007-08

No. of offices 2777 2812 2931

No. of employees 38774 38604 37496

Business per employee (in Rs. lakh) 396.00 555.00 710.00

Profit per employee (in Rs. lakh) 2.13 2.73 3.94

Capital and reserves & surplus 7844 8650 11044

Deposits 93662 124916 152034

Borrowings 4802 1143 3927

Investments 35114 34944 43870

Advances 59912 83621 106701

Interest income 7050 9004 11813

Other income 1127 1382 2051

Interest expended 3875 5427 7902

Operating expenses 2385 2544 2934

Cost of Funds (CoF) 4.03 4.58 5.33

Return on advances adjusted to CoF 3.28 3.69 3.51

Wages as % to total expenses 24.34 20.63 16.65

Return on Assets 0.79 0.80 0.89

CRAR 13.65 11.80 12.91

Net NPA ratio 0.87 0.60 0.47

(Source: http://rbidocs.rbi.org.in/rdocs/Publications/DOCs/87122.xls)

76

ICICI Bank

Particular 2005-06 2006-07 2007-08

No. of offices 569 716 1268

No. of employees 25384 33321 40686

Business per employee (in Rs. lakh) 905.00 1027.00 1008.00

Profit per employee (in Rs. lakh) 10.00 9.00 10.00

Capital and reserves & surplus 22556 24663 46820

Deposits 165083 230510 244431

Borrowings 38522 51256 65648

Investments 71547 91258 111454

Advances 146163 195866 225616

Interest income 14306 21996 30788

Other income 4181 6928 8811

Interest expended 9597 16358 23484

Operating expenses 5001 6691 8154

Cost of Funds (CoF) 4.01 5.34 6.40

Return on advances adjusted to CoF 4.58 4.08 4.33

Wages as % to total expenses 7.41 7.01 6.57

Return on Assets 1.30 1.09 1.12

CRAR 13.35 11.69 13.97

Net NPA ratio 0.72 1.02 1.55

(Source: http://rbidocs.rbi.org.in/rdocs/Publications/DOCs/87122.xls)

77

HDFC Bank

Particular 2005-06 2006-07 2007-08

No. of offices 515 666 743

No. of employees 14878 21477 37836

Business per employee (in Rs. lakh) 758.00 607.00 506.00

Profit per employee (in Rs. lakh) 7.39 6.13 4.97

Capital and reserves & surplus 5300 6433 11497

Deposits 55797 68298 100769

Borrowings 2858 2815 4479

Investments 28394 30565 49394

Advances 35061 46945 63427

Interest income 4475 6648 10115

Other income 1124 1516 2283

Interest expended 1930 3179 4887

Operating expenses 1691 2421 3746

Cost of Funds (CoF) 3.76 4.58 5.25

Return on advances adjusted to CoF 5.15 5.99 7.38

Wages as % to total expenses 13.45 13.87 15.07

Return on Assets 1.38 1.33 1.32

CRAR 11.41 13.08 13.60

Net NPA ratio 0.44 0.43 0.47

(Source: http://rbidocs.rbi.org.in/rdocs/Publications/DOCs/87122.xls)