1

The Cost of Equity for Indian Banks: A CAPM Approach

By

Dr. M. Thiripalraju, Professor & Director-Incharge
Indian Institute of Capital Markets
2
nd
floor, Hindavi Bhavan, Plot 13, Sector 1
Vashi, Navi Mumbai, Maharashtra, India.
Tel No. +91-022-27820127/27820153
Mobile No. 09819065454
Email : mtrajumuppalla@yahoo.com, mtraju@utiicm.com
&
Dr. Rajesh Acharya, Faculty member
ICFAI, Hyderabad.
Mobile No. 09666466169
Email : rajeshacharyah@gmail.com



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The Cost of Equity for Indian Banks: A CAPM Approach

Abstract

This paper examines the cost of equity for major banks in India in the wake of financial crisis.
Both public and private sector banks were covered over the period 2004-2009. Cost of equity is
estimated based on single-factor Capital Asset Pricing Model (CAPM). The cost of equity has
increased for almost all banks in the study period and most of the banks recorded highest cost of
equity in 2008 and a marginal decline in 2009. In case of portfolio cost of equity, public sector
and new private sector banks have shown an increasing trend in cost of equity from 2004 to
2008 and declined in 2009. But portfolio of old private sector banks has shown an increasing
trend throughout the study period. The rise in cost of equity is mainly associated with rise in the
risk free rate and partly due to increase in the sensitivity of bank stock returns to market risk.

JEL Classification: G01, G12, G21, G32.




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The Cost of Equity for Indian Banks: A CAPM Approach

I. Introduction
Cost of equity is defined as 'the rate of return investors require on an equity investment in a firm.
(Damodaran, A. 2000). It is the expected rate of return on the market value of an asset. Cost of
equity is estimated Irom market data because the implied cost oI a company`s equity should be
based on the market price of equity and not on the book value of the company. Thus by using
cost of equity which represents the market`s expectation, market value of the expected cash
flows from investment can be estimated. Cost of equity is a forward looking measure based on
expected return which is market driven. Typically cost of equity is measured in nominal terms
which include the expected inflation.

In the wake of financial crisis one commonly held belief is that banks should hold more common
equity because excessive leverage is regarded as a reason for the current financial crisis. If banks
hold more common equity in their capital structure, it helps to withstand the losses. But common
equity is also an expensive form of capital because investors expect higher returns as investing in
common equity is risky. Since the onset of financial crisis riskiness of investing in banks have
risen. This is evident in the fall in price of banking stocks and higher spreads for bank bonds
(King, 2009). Change in the bank riskiness may lead to an increase in the risk premium for
investing in banks and change in the risk free rate of interest may have changed the cost of
equity.

The main objective of the paper is to investigate the impact of financial crisis on cost of equity
for Indian banking sector. Even though Indian banking system did not have direct exposure to
sub- prime mortgage assets as well as to the failed financial institutions, the crisis has spread
through financial as well as real channels. Financial crisis has affected equity, money, forex, and
credit markets. Global liquidity squeeze has forced the banking sector to search for domestic
funds and capital outflow has put domestic equity markets under pressure resulting in fall in
4

stock prices. So it becomes timely to investigate the impact of these changes on expected returns
for investing in the common equity of the banking sector.

This study provides the estimates of cost of equity for 19 banks divided into three categories viz.
public sector banks, old private sector banks and new public sector banks (See Exhibit 1). The
six year period examined in the study includes the bull phase preceding the financial crisis and
bear phase during the crisis as well immediate policy response following the financial crisis.
Capital asset pricing model (CAPM) has been used to estimate the cost of equity. Even though
CAPM is questioned in the academic literature, it is applied extensively in the cost of equity
estimation. Since 2005 CAPM has been used by the Federal Reserve System as its only method
to estimate cost of equity (King (2009)).

The estimates of the cost of equity for banks increased steadily during first three years i.e. 2004
to 2006 whereas a sudden jump is observed during 2007 and 2008. Majority of the banks have
shown marginal decline in the cost of equity during 2009. Major contributor for increase in cost
of equity is rise in risk free rate of interest i.e. from 5.5 percent in 2004 to 9.5 percent in 2008.
Partly it is contributed by rise in the beta coefficient especially during 2007 and 2008.

The remainder of the paper is organized as follows: In section II we have reviewed the studies
relating to cost of equity followed by methodology of the study in section III. Data and the
sample of the study are described in section IV and section V deals with the empirical result of
the study. Section VI provides the statistical and economic reasons for change in the cost of
equity in the study period and finally section VII concludes the study with remarks on scope for
future work.

II. Literature Review:
In this section an attempt is made to examine some of the prior studies on cost of equity. We
confine only to those studies relating to the cost of equity for banks and methodological issues
relating to Capital Asset Pricing Model (CAPM) which is used in this study.


5

Zimmer and McCauley (1991) estimated the cost of equity for 34 international banks belonging
to six countries over the period 1984-1990. Return on equity was used as a proxy for estimating
cost of equity. The study has found significant difference in the cost of equity for banks across
countries. The US, UK and Canadian banks had cost of equity of around 10 percent, German and
Swiss banks with cost of equity of five percent to seven percent, and Japanese banks with cost of
equity of around three percent. They argued that banks with high cost of capital found it difficult
in competing in low margin business. Banks with low capital costs gained market share in US
wholesale market whereas banks with high cost of capital experienced a fall in the market share.
Fama and French (1996) argued that beta alone does not suffice to explain the changes in the expected
return. Other variables like price earnings ratio, cash flow price ratio, past sales growth etc. considerably
explain the future return. Empirically CAPM may fail due to bad proxies for market portfolio. So the
inefficient proxies for expected return and market portfolio could actually undermine the application of
CAPM.

Fama and French (1997) have argued that estimates of cost of equity based on CAPM are
alarmingly imprecise. The study reported that standard errors of more than three percent per year
are typical in the case of CAPM. The cost of equity estimates of individual firms and projects are
even more imprecise. The study has argued that this is mainly due to uncertainty about true
factor risk premiums and imprecise estimates of the loadings of industries on the risk factors.

Bruner et.al. (1998) made a survey and synthesis of the best practices in estimating cost of equity capital
through the survey of leading corporations and financial advisors. Regarding use of CAPM to estimate
cost of equity, authors found substantial disagreements in the choice of risk free rate of return, beta
estimates and equity market risk premium. They argued that choice of different risk free rates can
significantly affect the cost of equity estimates. As far as beta estimation is concerned, finance theory
states that it is a forward looking measure. But in practice it is estimated largely based on historical data.
Selection of time period for estimation also affects the final outcome. Increasing the time period for
estimation increases the statistical reliability but may include irrelevant past information. Choice of the
market index is also another contentious issue as beta providers use a variety of market indices as market
portfolio proxy. Finally, equity market risk premium is calculated by extrapolating the historical returns
into future. Both value and method of calculating equity market premium for estimating cost of equity
differed considerably. Finally, authors argued that CAPM is the preferred model for estimating cost of
equity in practice.
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Maccario et al. (2002) have examined the cost of equity for major banks of G10 countries. They
used earnings forecasts to estimate the cost of equity for major banks over 1993- 2001. They
found that estimated average cost of equity has declined during the study period. They also found
that difference in the cost of equity for major banks have declined especially in the last five years
of the study period. Cost of equity had strong relation with both micro economic variables (Tier I
capital, growth rate of loan losses, expected growth rate in earnings, and payout ratio) and macro
economic variables (Real long term interest rates, market premium and GDP growth rate).

Harris et. al. (2003) estimated the ex ante cost of equity for S&P 500 firms to make a choice between
global and domestic CAPM. They estimated ex ante returns for S&P 500 firms for period between 1983-
1998. The study has found that domestic CAPM with ex ante expected return provided better fit than with
global CAPM. Finding was surprising given integration of capital markets around the world.

Fama and French (2004) have highlighted the outcome of using CAPM used to estimate cost of
equity. They argued that the relation between average return and average beta is flatter than
predicted by the Sharpe and Lintner version of CAPM. This leads to too high cost of equity
estimates for high beta stocks and too low to low beta stocks relative to historical average
returns.

Barnes and Lopez (2006) have examined several cost of equity estimates based on the Capital
Asset Pricing Model (CAPM) and compared them using econometric and materiality criteria.
The study has found that cost of equity could be reasonably estimated by using simple CAPM.
They did not find compelling evidences to extend the model to include factors like firm leverage,
business concentration etc. Since this is an empirical exercise, the result could vary in a different
context.

King (2009) examined the real cost of equity estimates for banks in six countries for 1990-2009
period. The study is based on single factor Capital Asset Pricing Model (CAPM). Empirical
evidence has shown that real cost of equity has declined during 1990-2005 period whereas
increased from 2006 onwards. The trends were mainly due to decline in the risk free rate and
CAPM beta which measures the sensitivity of bank return with market return. The study has also
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highlighted the difficulty of estimating expected returns using CAPM which showed wide
variation across banks.

From the review of the existing literature it becomes quite pertinent that, estimating cost of
equity for banks assumes lot of significance in present circumstance. Financial crisis has hit the
banks from both financial channel as well as confidence channel. From methodological
perspective academicians have identified several theoretical as well as empirical limitations in
CAPM. In spite of these shortcomings, CAPM is still one of the extensively applied techniques
in estimating cost of equity.

III. Methodology:
Cost of equity is important for both managers as well as investors. It is a major input to the
management while deciding on new investment and on capital structure of the firm. It is equally
important to investors for valuation of equity investment. CAPM is the most extensively applied
method in estimating the cost of equity. It is a set of predictions regarding equilibrium expected
return on risky assets. It quantifies the tradeoff between risk and expected return based on a
single risk factor i.e. market return. A mean- variance efficient portfolio investor tries to
maximize return for a given level of risk. Nominal cost of equity based on this framework for a
stock is expressed as follows:

(1)

where is the expected return on stock , is the expected return on market portfolio,
and is the nominal rate of return on risk free asset. The expected return or cost of equity is
expressed as linear combination of risk free rate and firm specific risk premium. Equity market
risk premium is the difference between expected market return and risk free rate. It is the rate of
return that an equity investor expects to earn for investing in equity market rather than investing
in risk free asset. Risk premium is the compensation for bearing additional risk. is the
CAPM beta which is a measure of systematic risk of investment. In other words, it is the
covariance of individual security`s return with market wide return which is divided by the
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variance of market return. Firm specific risk premium is obtained by multiplying the individual
securities beta and equity market risk premium.

The empirical estimation of CAPM is carried out by using historical returns assuming historical
returns are good proxy for expected return. Monthly realized excess return i.e. subtracting risk
free return from actual return is used in the estimation of CAPM. Ordinary least squares (OLS)
method is used in the estimation of the parameters of CAPM. Specification of the model is as
follows:

(2)

where stands for the stock of a given firm and stands for the time period. CAPM beta is the
slope coefficient of the regression equation. In an efficient market intercept should not be
statistically significantly different from zero and residuals should be IID. Rolling regression is
used in the estimation of CAPM using five years monthly return. It results in monthly beta
coefficients from sixth year onwards till the end of the study period.

Cost of equity changes either due to changes in the risk free rate or changes in the firm specific
premium. Risk free rate is determined by the central bank of the country. Firm specific premium
consists of two components viz. CAPM beta and equity market premium. Beta captures the
sensitivity oI the individual stock`s return to market risk. Beta of greater than one shows that
individual stock`s return is more variable than market return whereas less than one shows stock`s
return is less variable than the market return. Higher beta results in higher firm specific premium
and vice versa. Over a period of time beta can vary either due to changes in the individual
stock`s return or overall market movement.

Equity market risk premium is the second component of firm specific premium. This is the rate
of return over risk free rate that investors require to invest in equities instead of risk free assets.
Equity market risk premium is unobservable and forward looking measure. The usual practice to
arrive at a proxy for risk premium is by comparing the historical returns and risk free rate. In this
study we arrived at a proxy for risk premium by taking the compounded annual growth rate of
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stock market for 15 years and the risk free rate of the corresponding period i.e. subtracting risk
free rate from market return. It is constant throughout the study period.

Implementation of the CAPM approach for measuring cost of equity is based on certain
assumptions and estimates may be sensitive to these assumptions. First, bank specific premium is
based on the assumption that equity market risk premium is constant. Due to this assumption
bank specific premium changes only due to changes in CAPM beta. But there is no simple way
to estimate the time varying equity market premium. Second, CAPM beta is estimated by using
rolling regression for monthly data of five years. Since estimation windows are overlapping, it
results in slow changes in the beta over time. This could be avoided by estimating the beta for
each year separately by using monthly observations. But it reduces the degree of freedom
drastically and may result in noisier estimates.

IV. Data and Sample:
The study is based on a sample of 19 bank stocks which are listed in Bombay Stock Exchange.
Sample is drawn based on the availability of data during the time period. We have adopted the
Indian Banks Association (IBA) classification of banks into three categories viz. public sector
banks, new private sector banks and old private sector banks. There are 21 public sector banks,
17 new private sector banks, and eight old private sector banks (See Exhibit 1). Out of 46 banks,
we have selected all banks having continuous price data from January 1999. It resulted in a
sample consisting eight public sector banks, five new private sector banks and six old private
sector banks.

Study period ranges from January 1999 to October 2009. Monthly data on closing bank stock
prices and Sensex index values are obtained from CMIE Prowess database. Maximum rate of
interest for deposits above one year maturity is taken as proxy for risk free rate. It is obtained
from CMIE Business Beacon database. We have calculated the risk premium by taking
compounded annual growth rate of Sensex return and risk free rate from January 1995 to
October 2009.
10

V. Empirical Result:
Empirical result of the study is organized as follows: Tables 1 to 3 deals with cost of equity
estimates for public sector, new private sector and old private sector banks respectively. Table 4
deals with the cost of equity estimates for portfolios of banks. All public sector banks in the
sample have shown an increase in the cost of equity since 2004 onwards and 2008 witnessed
highest cost of equity in the study period. Marginal decline in cost of equity is observed for
2009. This shows that cost of equity is following the same trend as risk free rate and also
increase in the sensitivity of the bank return to market risk especially for 2008.

Slightly different pattern is observed in case of new and old private sector banks. Out of five new
private sector banks, two banks viz. Indusind Bank and Kotak Mahindra Bank have shown an
increasing trend throughout. Rest three banks have shown same trend as the public sector banks.
In case of six old private sector banks, three banks viz. City Union Bank, Dhanalaxmi Bank, and
South Indian Bank have shown an increasing trend. Whereas rest of the banks have shown the
same trend as public sector banks. In spite of decline in risk free rate in 2009 total five banks
have shown higher cost of equity in the entire study period. This is solely due to the rise in the
sensitivity of the bank return to market return.

Sectoral cost of equity estimates i.e. for equally weighted portfolio of the public sector, new and
old private sector banks have shown the same trend as the majority of the individual banks. In
case of public sector banks there is continuous rise in cost of equity till 2008 and marginal
reduction in 2009. Rise in the cost of equity is directly attributable to rise in risk free rates and
rise in beta especially for 2008. Reduction in both risk free rate and fall in beta is mainly
responsible for decline in the cost of equity for 2009. Portfolio of the new private sector banks
also has shown the similar pattern except for relatively smaller reduction in cost of equity for
2009. Old private sector banks portfolio has shown slightly different pattern. For first four years
i.e. 2004 to 2007, cost of equity estimates are relatively small compared to both public sector and
new private sector banks. This is mainly due to the relatively smaller beta coefficients. But
during 2008 and 2009, there is substantial increase in the size of beta coefficients which resulted
in increase in the cost of equity.
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Yearly return is also reported along with cost of equity. There is wide variation in return across
banks. But in 2008 all banks reported large negative return followed by positive return in 2009
reflecting impact of financial crisis and subsequent recovery. During rest of the time period,
largely banks have yielded return above the cost of equity of the corresponding period.

VI. Reasons for Change in the Cost of Equity Estimates:
Cost of equity estimated from CAPM is a combination of two components viz. risk free rate and
bank specific risk premium. Risk free rate is the yardstick for evaluating investment in equities
which involves assuming higher risk, hence investors expect premium over and above the risk
free rate. In India since 2004 to 2008 there is a continuous rise in the risk free rate i.e. highest
deposit rate with a maturity of over one year. It has increased from 5.58 percent in 2004 to 9.5
percent in 2008. This has contributed to the rise in the cost of equity for first four years. In 2009
risk free rate has declined to 8.29 percent which in turn reflected in decline in the cost of equity
for majority of the banks.

In the case of cost of equity based on CAPM, bank specific premium is the product of country`s
equity market risk premium and stock`s beta. Since the equity market premium is taken as
constant during the study period bank specific premium changes only due to changes in the beta
i.e. sensitivity oI the bank`s return to market risk. There is a clear cut rise in the beta for 2008 for
majority of the banks and it was highest in the entire study period. Statistically betas increase
either due to rise in the covariance of bank return with market return or due to fall in the
variability of the market return. In this case both increased but the rate of increase of the former
was higher than the latter. Intuitively an economic justification could be given for this
phenomenon. During the financial crisis increasing covariance of bank return with market return
shows the investors perception about the riskiness of investment in banks common equity. It
appears investors have priced the greater risk of investing in banks during financial crisis.

VII. Conclusion:
We examine the cost of equity for Indian banks in both public sector and private sector based on
single factor CAPM. The cost of equity increased for all banks in the study period though
declined marginally in 2009. Major contribution for rise cost of equity came from increase in risk
12

free rate and marginally by rising CAPM beta. Cost of equity is highest in 2008 which makes it
abundantly clear that riskiness of investing in banking stocks has increased during financial
crisis. Findings of our study are similar to our expectations, that financial crisis is associated with
higher cost of equity. It also supports the findings of some international studies which reported
rise in cost of equity since beginning of financial crisis due to rise in bank betas.

Present study can be extended in some specific ways. Empirical evidence has suggested a clear
difference in the cost of equity estimates for public sector and private sector banks especially the
old private sector banks during years preceding financial crisis. Beta and resultant bank specific
premium are at a lesser level compared to public sector and new private sector banks. Apart from
this, only public sector banks experienced substantial reduction in cost of equity for 2009
whereas for private sector banks it is still at higher level or increased for the same period. It may
be interesting to explore cost of equity based on the ownership structure of the banks.
13

References:
Barnes, M L and J A Lopez (2006). 'Alternative measures oI the Federal Reserve Banks` cost oI
equity capital. Journal of Banking and Finance, no 30, pp 1687711.
Bruner, R. F., Eades, K. M., Harris, R. S., and Higgins, R. C. (1998). 'Best Practices in Estimating the
Cost of Capital: Survey and Synthesis. Financial Practice and Education, spring/ summer 1998, pp. 13-
28.
Damodaran, A. (2000). 'Investment Valuation: Tools and Techniques for Determining the Value of Any
Asset. 2d ed. New York: John Wiley & Sons, Inc., pp. 182.
Fama, E. F., and French, K. (1996). 'The CAPM is Wanted, Dead or Alive. The Journal of
Finance, Vol. 51, No. 5, pp. 1947-1958.
Fama, E. F., and French, K. (1997). !Industry cost oI equity. Journal of Financial Economics
43, 1997 153-193
Fama, E. F., and French, K. (2004)s. 'The Capital Asset Pricing Model: Theory and Evidence.
Journal of Economic Perspectives, Vol 18, summer 2004, pp. 25-46.
Harris, R. S., Marston, F. C., Mishra, D. R., and O`Brien, T.J. (2003). 'Ex Ante Cost of Equity Estimates
oI S&P 500 Firms: The Choice Between Global and Domestic CAPM. Financial Management, Autumn,
pp. 51-66.
King, M. R. (2009). !The cost of equity for global banks: a CAPM perspective from 1990 to
2009. BIS Quarterly Review, pp 59-73.
Maccario, A. D. and Zazzara, A.S.C. (2002). 'Is Banks` Cost oI Equity Capital DiIIerent Across
Countries? Evidence from the G10 Countries Major Banks. SDA Bocconi Research Division
Working Paper No.02-77
Zimmer, S A and R N McCauley (1991): 'Bank cost of capital and international competition,
FRBNY Quarterly Review, winter, pp 3359.








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Table 1: Components of the Cost of Equity Estimates for Public Sector Banks

Bank of Baroda
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 9.86 15.44 9.83 1.21
2005 6.27 11.13 17.4 16.09 1.36
2006 7.31 10.88 18.19 -4.02 1.33
2007 9.18 10.57 19.75 60.95 1.29
2008 9.5 10.39 19.89 -32.69 1.28
2009 8.29 9.07 17.36 69.1 1.12
2004-09 7.55 10.35 17.86


Table 1- Continued

Bank of India
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 7.19 12.77 26.38 0.9
2005 6.27 9.32 15.59 8.02 1.15
2006 7.31 8.46 15.77 14.84 1.05
2007 9.18 9.4 18.58 20.35 1.16
2008 9.5 10.72 20.22 24.38 1.32
2009 8.29 9.79 18.08 24.97 1.2
2004-09 7.55 9.04 16.56

15

Table 1- Continued

Corporation bank
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 8.03 13.61 28.67 1
2005 6.27 7.76 14.03 4.17 0.96
2006 7.31 8.18 15.49 2.03 1.01
2007 9.18 8.7 17.87 34.96 1.07
2008 9.5 9.88 19.38 -58.88 1.21
2009 8.29 9.98 18.27 91.2 1.22
2004-09 7.55 8.66 16.17

Table 1- Continued

Dena Bank
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 7.6 13.18 29.31 0.95
2005 6.27 8.84 15.11 -10.49 1.09
2006 7.31 8.27 15.58 -2.8 1.03
2007 9.18 8.01 17.19 76.81 0.99
2008 9.5 8.99 18.49 -71.41 1.11
2009 8.29 9.3 17.59 75.34 1.14
2004-09 7.55 8.45 15.96








16

Table 1- Continued

Oriental Bank of Commerce
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 6.27 11.85 37.09 0.78
2005 6.27 6.93 13.2 -16.07 0.86
2006 7.31 6.57 13.88 -10.05 0.82
2007 9.18 7.76 16.94 25.55 0.96
2008 9.5 9.04 18.54 -50.33 1.12
2009 8.29 8.49 16.78 60.09 1.05
2004-09 7.55 7.4 14.91

Table 1- Continued

State Bank of India
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 8.38 13.96 9.08 1.04
2005 6.27 9.41 15.69 34.48 1.16
2006 7.31 8.8 16.11 34 1.09
2007 9.18 8.92 18.09 73.4 1.1
2008 9.5 9.38 18.88 -51.79 1.15
2009 8.29 9.55 17.84 70.23 1.17
2004-09 7.55 9.04 16.56

17

Table 1- Continued

Syndicate Bank
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 NA NA 60.92 NA
2005 6.27 8.92 15.19 44.62 1.1
2006 7.31 9.47 16.78 -25.8 1.17
2007 9.18 9.92 19.1 44.43 1.22
2008 9.5 10.36 19.86 -38.62 1.27
2009 8.29 9.34 17.63 46.91 1.15
2004-09 7.55 9.58 17.09

Table 1- Continued

IDBI Bank
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 9.89 15.46 48.88 1.22
2005 6.27 12.28 18.55 -12.24 1.49
2006 7.31 13.2 20.51 -16.74 1.6
2007 9.18 13.79 22.97 48.87 1.67
2008 9.5 13.56 23.06 -51.75 1.64
2009 8.29 12.02 20.31 78.87 1.46
2004-09 7.55 12.39 19.9








18

Table 2: Components of the Cost of Equity Estimates for New Private Sector Banks
Axis Bank
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 8.5 14.08 14.41 1.05
2005 6.27 9.22 15.49 32.84 1.14
2006 7.31 9.09 16.4 33.02 1.12
2007 9.18 9.22 18.4 59.39 1.14
2008 9.5 9.31 18.81 -78.9 1.15
2009 8.29 9.86 18.15 80.29 1.21
2004-09 7.55 9.16 16.68
Table 2- Continued
HDFC Bank
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 4.39 9.97 40.89 0.56
2005 6.27 3.95 10.23 22.59 0.5
2006 7.31 4.72 12.03 33.85 0.59
2007 9.18 5.99 15.16 47.16 0.75
2008 9.5 7.61 17.11 -45.22 0.95
2009 8.29 7.86 16.15 58.88 0.97
2004-09 7.55 5.47 12.98
Table 2- Continued
ICICI Bank
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 10.75 16.33 22.77 1.32
2005 6.27 10.51 16.78 48.33 1.29
2006 7.31 9.74 17.05 37.96 1.2
2007 9.18 9.17 18.34 27.03 1.13
2008 9.5 10.4 19.9 -93.82 1.27
2009 8.29 11.02 19.31 76.1 1.35
2004-09 7.55 10.21 17.72
19

Table 2- Continued

Indusind Bank
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 8.66 14.24 36.54 1.07
2005 6.27 8.38 14.65 0.43 1.04
2006 7.31 7.67 14.98 -10.35 0.95
2007 9.18 7.72 16.9 87.83 0.96
2008 9.5 10.1 19.6 -95.71 1.24
2009 8.29 11.8 20.09 138.48 1.44
2004-09 7.55 8.84 16.35

Table 2- Continued

Kotak Mahindra
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 9.96 15.54 -33.7 1.22
2005 6.27 9.39 15.66 -25.17 1.16
2006 7.31 9.14 16.45 53.61 1.13
2007 9.18 9.34 18.51 102.32 1.15
2008 9.5 11.13 20.63 -106.1 1.36
2009 8.29 12.94 21.23 103.35 1.57
2004-09 7.55 10.13 17.64

20

Table 3- Components of the Cost of Equity Estimates for Old Private Sector Banks

Bank of Rajastan
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 8.15 13.73 53.98 1.01
2005 6.27 9.06 15.33 -22.01 1.12
2006 7.31 8.51 15.82 -26.29 1.05
2007 9.18 9.39 18.56 145.2 1.16
2008 9.5 12.93 22.43 -124.2 1.57
2009 8.29 13.75 22.04 88.19 1.66
2004-09 7.55 9.94 17.45


Table 3- Continued

City Union Bank
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 5.58 11.16 31.93 0.7
2005 6.27 5.45 11.72 5.93 0.68
2006 7.31 4.43 11.74 40.9 0.56
2007 9.18 4.78 13.95 86.61 0.6
2008 9.5 8.18 17.68 -109.5 1.02
2009 8.29 9.71 18 78.16 1.19
2004-09 7.55 5.96 13.48

21

*Table 3- Continued
Dhanalaxmi Bank
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 NA NA 23.36 NA
2005 6.27 4.81 11.08 -9 0.61
2006 7.31 6.28 13.59 62.6 0.78
2007 9.18 6.52 15.69 50.08 0.81
2008 9.5 7.88 17.38 -49.06 0.98
2009 8.29 10.18 18.47 111.73 1.25
2004-09 7.55 6.77 14.28
Table 3- Continued
Federal Bank
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 9.31 14.88 -47.14 1.15
2005 6.27 7.5 13.77 18.01 0.93
2006 7.31 6.91 14.22 18.91 0.86
2007 9.18 6.58 15.76 30.35 0.82
2008 9.5 7.34 16.84 -65.19 0.91
2009 8.29 8.24 16.53 59.49 1.02
2004-09 7.55 7.56 15.08
Table 3- Continued
ING Vyshya Bank
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 5.43 11.01 -2.64 0.68
2005 6.27 5.68 11.95 -124.8 0.71
2006 7.31 6.45 13.76 -1.23 0.81
2007 9.18 7.3 16.48 51.3 0.91
2008 9.5 6.31 15.81 -69.06 0.79
2009 8.29 7.51 15.8 74.25 0.93
2004-09 7.55 6.36 13.87
22

Table 3- Continued

South Indian Bank
Risk Free Rate
(A)
Bank Premium
(B)
Cost of Equity
(A+B) Return Beta
2004 5.58 6.45 12.02 -3.33 0.81
2005 6.27 7.67 13.94 -2.07 0.95
2006 7.31 7.76 15.07 18.89 0.96
2007 9.18 7.17 16.35 81.77 0.89
2008 9.5 8.52 18.02 -119.4 1.06
2009 8.29 10 18.29 103.39 1.23
2004-09 7.55 7.77 15.28

Table 4- Sector Wise Portfolio Components of Cost of Equity

Banking Risk Premium Cost of Equity
Year Risk Free
Rate (A)
Public
Sector
Banks (B)
New
Private
Sector
Banks (C)
Old
Private
Sector
Banks (D)
Public
Sector
Banks
(A+B)
New Private
Sector Banks
(A+C)
Old Private
Sector
Banks
(A+D)
2004 5.58 7.90 8.70 6.21 13.48 14.28 11.79
2005 6.27 8.89 8.94 6.70 15.17 15.21 12.97
2006 7.31 8.53 8.91 6.72 15.84 16.22 14.03
2007 9.18 8.89 9.19 6.96 18.07 18.37 16.14
2008 9.50 9.74 10.35 8.52 19.24 19.85 18.02
2009 8.29 9.36 10.91 9.89 17.65 19.20 18.18
2004-09 7.55 8.85 9.41 7.30 16.40 16.96 14.85






23

Exhibit- 1 Classification of Banks
Sl. No Nationalized Banks Sl. No Old Private Sector Banks (Contd.)
1 Allahabad Bank 23 ING Vysya Bank Ltd.*
2 Andhra Bank 24 Lord Krishna Bank Ltd.
3 Bank of Baroda* 25 SBI Commercial & International Bank Ltd.
4 Bank of India* 26 Tamilnad Mercantile Bank Ltd.
5 Bank of Maharashtra 27 Bank of Rajasthan Ltd.*
6 Canara Bank 28 Catholic Syrian Bank Ltd.
7 Central Bank of India 29 Dhanalakshmi Bank Ltd.*
8 Corporation Bank* 30 Federal Bank Ltd.*
9 Dena Bank* 31 Jammu & Kashmir Bank Ltd.
10 Indian Bank 32 Karnataka Bank Ltd.
11 Indian Overseas Bank 33 Karur Vysya Bank Ltd.
12 Oriental Bank of Commerce* 34 Lakshmi Vilas Bank Ltd.
13 Punjab & Sind Bank 35 Nainital Bank Ltd.
14 Punjab National Bank 36 Ratnakar Bank Ltd.
15 Syndicate Bank* 37 Sangli Bank Ltd.
16 UCO Bank 38 South Indian Bank Ltd.*
17 Union Bank of India
New Private Sector Banks
18 United Bank of India 39 Axis Bank Ltd.*
19 Vijaya Bank 40 Centurion Bank of Punjab Ltd.
Other Banks 41 Development Credit Bank Ltd.
20 State Bank of India* 42 HDFC Bank Ltd.*
Other Public Sector Banks 43 ICICI Bank Ltd.*
21 IDBI Bank Ltd.* 44 Indusind Bank Ltd.*
Old Private Sector Banks 45 Kotak Mahindra Bank Ltd.*
22 City Union Bank Ltd.* 46 YES Bank
Source: Indian Banks Association.
* Banks included in the study.