Evaluation of Banking Performance

Ratio Analysis technique is often used for

evaluating banking performance.
Broadly speaking, there are two important
performance dimensions, namely:
Profitability
Risk

Prepared by: Mr. Amir Ikram

Profitability ratios:

Return on Equity:
Net Income after Taxes
=
Equity Capital

Return on Assets:
Net Income after Taxes
=
Total Assets

Net Interest margin:

Interest Revenue Interest Expense
=
Total Assets

Prepared by: Mr. Amir Ikram

Profitability ratios:

Net Non-Interest margin:

Non-interest Revenue Non-interest Expense
=
Total Assets

Net bank operating margin:

Total operating Revenues Total operating Expenses
=
Total Assets

Earning Per share of stock (EPS):

Net Income after taxes
=
Common shares outstanding
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Risk:
Main Risks faced by banks:

Credit Risk
Liquidity Risk
Market Risk
Interest-rate Risk
Earning Risk
Solvency Risk
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Risk Analysis:
Credit risk:
The danger of default by the borrower
to whom the bank has extended credit

Prepared by: Mr. Amir Ikram

Credit risk_Indicators:

Non-performing loans
=
Total loans & leases

Net Charge-offs

=
Total loans & leases

Provision for loan losses

=
Total loans & leases or Equity capital

Allowance for loan losses

=
Total loans & leases or Equity capital
Prepared by: Mr. Amir Ikram

Credit risk_Indicators:
Another popular credit risk measure:

Total loans
=
Total deposits

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Liquidity risk:
The danger of having insufficient
cash to meet obligations when due.

Prepared by: Mr. Amir Ikram

Liquidity risk_indicators:
Purchased funds
=
Total Assets

Net loans
=
Total Assets
The higher the ratio, the greater is the risk.

Prepared by: Mr. Amir Ikram

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Liquidity risk_indicators:

Cash & due from other banks

=
Total Assets

Cash & Govt. Securities

=
Total Assets
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Liquidity risk:
How to reduce banks exposure to liquidity risk?
1) Increasing the proportion of bank funds committed to cash
& marketable assets.
2) Use longer-term liabilities to fund the banks operations.

Prepared by: Mr. Amir Ikram

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Market Risk:
The danger of changing market values
of bank assets, liabilities, and equity
that may bring about loss.

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Market Risk:
Main reasons:

Changes in market interest rates

Changes in currency prices
Shifting public demand for bank services
Alteration in central bank policy

Banks perception in the eyes of investor.

Prepared by: Mr. Amir Ikram

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Market Risk_indicators:

Book value of Assets

=
Market value of Assets

Book value of Equity Capital

=

Market value of Equity Capital

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Market Risk_indicators:

Book value of bonds & other fixed assets

=
Market value of bonds & other fixed assets

Market value of common & preferred stock

=
Common & preferred shares outstanding
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Interest Rate risk:

The danger of shifting interest rates may
adversely affect a banks net income, the
value of its assets, or equity.

Prepared by: Mr. Amir Ikram

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Interest Rate risk:

E.g, if a banks flexible-rate assets are greater than its
flexible-rate liabilities, i.e.,
Flexible-rate assets/Flexible-rate liabilities > 1
And if interest-rate increases???

Here it will be beneficial for the bankresulting in increased

profit margin.

Prepared by: Mr. Amir Ikram

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Interest Rate risk:

Profit margin will be higher, if

Interest-rate falling
Flexible-rate assets < Flexible-rate liabilities

Interest-rate rising
Flexible-rate assets > Flexible-rate liabilities

Prepared by: Mr. Amir Ikram

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Interest-rate risk_indicators:

Interest-sensitive Assets
=

Interest-sensitive Liabilities

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Interest-rate risk_indicators:

Uninsured Deposits
=

Total Deposits
The higher the ratio, the greater is the risk.

Prepared by: Mr. Amir Ikram

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Earnings risk:
The danger that a banks rate of return
on assets (ROA) or equity (ROE) or its
net earnings may fall.

Prepared by: Mr. Amir Ikram

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Earnings risk_Indicators:
Standard deviation or Variance of net income (NI).
Standard deviation or Variance of the banks
return on Assets (ROA) & return on equity
(ROE).
The higher the standard deviations, the more risky the bank
is.

Prepared by: Mr. Amir Ikram

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Solvency risk:
Risk to banks long-term survival is called
solvency risk. The danger that a bank may
fail due to negative profitability and erosion
of its capital.

Prepared by: Mr. Amir Ikram

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Solvency risk:
Reasons:
Excessive number of bad loans
Decline in market value to the large portion of
banks security portfolio.
Market discipline:
Increased chance of failing fall in stocks market value
high interest rates on borrowings (to attract needed
funds).

Prepared by: Mr. Amir Ikram

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Solvency risk_indicators:
Yield on bank debt issues Yield on Govt. securities *
*Govt. securities should be of the same maturity.
Greater the difference, the higher is the risk.

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Solvency risk_indicators:

Banks Stock price

=
Annual earnings per share

Net-worth (equity capital)

=

Total Assets
Decline in ratio Greater risk exposure.

Prepared by: Mr. Amir Ikram

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Solvency risk_indicators:

Purchased funds
=
Total Liabilities

Net-worth (equity capital)

=
Risky Assets*
* Risk assets mainly include loans and securities.

Prepared by: Mr. Amir Ikram

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Other forms of risk:

Inflation Risk
Currency or Exchange rate risk
Political risk
Crime risk

Prepared by: Mr. Amir Ikram

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