Reading a fictional bank’s spread and asset quality

The case and its answers

Every question of this case, with its answer and why each other option is wrong.

A fictional bank has average earning assets of ₹5,000 crore. Annual interest income is ₹450 crore and interest expense ₹250 crore. Gross advances at year-end are ₹4,000 crore, including gross non-performing advances of ₹120 crore. Specific provisions held against those non-performing advances are ₹60 crore. Net profit is ₹30 crore and average shareholders’ equity ₹500 crore. For this exercise, NIM is net interest income divided by average earning assets, gross NPA ratio uses gross advances, and provision coverage uses only the stated specific provisions divided by gross NPA. These definitions are supplied to avoid differences among reporting conventions.

All people, firms, prices and contract terms are fictional.

Ignore taxes and transaction costs unless the case explicitly includes them.

1. Q1What is the bank’s net interest margin using the supplied definition?

   • A

     Option A. 5%

     Why it is wrong: This divides interest expense by earning assets.

   • B

     Option B. 6%

     Why it is wrong: This is ROE, using a different numerator and denominator.

   • C

     Option C. 9%

     Why it is wrong: This divides gross interest income by earning assets.

   • D

     Option D. 4% — Correct answer

   Answer: D. (₹450 − ₹250)/₹5,000 × 100 = 4%. Remember: NIM measures net interest income relative to the specified earning-asset base.

   Hint, shown before you answer in practice mode: Subtract interest expense before dividing by earning assets.

   XV-S2-C02-Q1mediumnumerical

   Study this unit

2. Q2What is the gross NPA ratio?

   • A

     Option A. 6%

     Why it is wrong: This is unrelated to the stated NPA denominator.

   • B

     Option B. 1.50%

     Why it is wrong: This substitutes provisions for gross NPA.

   • C

     Option C. 2.40%

     Why it is wrong: This uses earning assets rather than gross advances.

   • D

     Option D. 3% — Correct answer

   Answer: D. ₹120 crore ÷ ₹4,000 crore × 100 = 3%. Remember: Asset-quality ratios require the correct loan balance as denominator.

   Hint, shown before you answer in practice mode: Use the ₹4,000 crore gross-advances base.

   XV-S2-C02-Q2mediumnumerical

   Study this unit

3. Q3What provision coverage follows the case definition?

   • A

     Option A. 50% — Correct answer

   • B

     Option B. 200%

     Why it is wrong: This reverses NPA and provisions.

   • C

     Option C. 1.50%

     Why it is wrong: This divides provisions by all advances.

   • D

     Option D. 100%

     Why it is wrong: The provisions are half, not equal to, gross NPA.

   Answer: A. ₹60 crore ÷ ₹120 crore × 100 = 50%. This is not a claim about any required regulatory ratio. Remember: A coverage ratio should identify which provisions and exposures it includes.

   Hint, shown before you answer in practice mode: Compare provisions with the specific impaired-loan amount.

   XV-S2-C02-Q3mediumnumerical

   Study this unit

4. Q4What is return on average equity?

   • A

     Option A. 4%

     Why it is wrong: This is net interest margin.

   • B

     Option B. 0.60%

     Why it is wrong: This divides profit by earning assets instead of equity.

   • C

     Option C. 6% — Correct answer

   • D

     Option D. 10%

     Why it is wrong: This is not supported by the profit and equity given.

   Answer: C. ₹30 crore ÷ ₹500 crore × 100 = 6%. Remember: Profitability, interest spread and credit quality are separate analytical dimensions.

   Hint, shown before you answer in practice mode: Use net profit and average shareholder equity.

   XV-S2-C02-Q4mediumnumerical

   Study this unit