Tunis Business School

ANALYSIS OF COMMERCIAL BANKS

PERFORMANCE

Management of Financial Institutions

Dr. Yosra Ghabri
Spring 2024

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Learning Objectives
You should Understand:

◼ The ROE equation

◼ Other profitability measures

◼ Market measures of bank performance

◼ Other non financial measures

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Commercial Bank Performance
◼ One way to identify performance, weaknesses
and problem areas of a bank is by analyzing
financial statements.

◼ In particular an analysis of selected accounting

ratios, allows a bank manager to evaluate:
- the bank’s current performance,
- the change in its performance over time,
- its performance compared to that of competitor
banks.

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 Ratio Analysis

◼ Peer Analysis: cross sectional analysis of

ratios across a group of banks. Compare with
others in same business situation.

◼ Trend Analysis: time series analysis of

ratios over a period of time. Compare
performance with previous periods.

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 THE RETURN ON EQUITY: ROE

◼ Return on equity is defined as:

◼ ROE measures the profitability of a company relative to

the equity provided by its shareholders.
◼ Return on equity measures a bank’s profitability by
revealing how much profit the bank generates with the
money shareholders have invested.

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◼ ROE is the basic measure of stockholder’s
returns.

◼ Generally, bank stockholders prefer ROE to be

high. It is possible, however that an increase in
ROE indicates increased risk.

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THE RETURN ON EQUITY: ROE
◼ ROE increases if total equity capital decreases to net
income:

ROE=NET INCOME / TOTAL EQUITY CAPITAL

◼ A large drop in equity capital may result in a violation of

minimum regulatory capital standards and an increased
risk of insolvency for the bank.
◼ An increase in ROE may simply result from an increase
in a bank’s leverage, an increase in its debt to equity
ratio.

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THE RETURN ON EQUITY: ROE

◼ To identify potential problems, ROE can be decomposed

into 2 components parts as follows:

➢ ROE=NET INCOME / TOTAL EQUITY CAPITAL

➢ ROE = (NET INCOME/TOTAL ASSETS)*(TOTAL ASSETS/EQUITY
CAPITAL)
➢ ROE = ROA * EM

◼ ROA is a measure of profitability linked to the asset size

of the bank. It determines the net income produced per
one unit of assets.

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◼ EM (equity multiplier), is a measure of the
degree of financial leverage employed by the
bank.
◼ It measures the value of assets funded with
each unit of equity capital.

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THE RETURN ON EQUITY: ROE

◼ Since EM measures financial leverage, it represents

both profit and risk measure:

ROE = ROA * EM
EM = (TOTAL ASSETS/EQUITY CAPITAL)

– EM affects a bank’s profits because it has a multiplier

impact on ROA to determine a bank’s ROE.
– EM represents a risk measure because it reflects how
many assets can go into default before a bank becomes
insolvent.

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◼ Large value of EM indicates a large amount of debt
financing relative to stockholders’ equity.
◼ In other terms, changes in the EM can influence a bank's
ROE, as it affects the amount of leverage (or debt) used
relative to equity.
◼ Higher leverage (a higher equity multiplier) can magnify
the impact of ROA on ROE.
◼ This is because higher leverage can amplify both profits
and losses, making the ROE more sensitive to changes
in ROA.

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 THE RETURN ON EQUITY: ROE

◼ When the leverage (EM) is high, banks are

accepting a lot of deposits and can earn high
income levels.
◼ A high EM mutliplies profits when profits are
positive, but also does with losses.

ROE = ROA * EM

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◼ An increase in ROE due to an increase in the
EM means that the bank’s levergae
increased but also indicates high insolvency
risk.

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EXAMPLE
◼ Consider 2 competing banks, each holding 100 million in
assets with identical composition and same asset quality.

◼ One bank is financed with 90 million in debt and 10

million in total equity, while the other bank is financed
with 95 million in debt and just 5 million in total equity.

◼ EM = 100/10 = 10 for the first bank;

◼ EM = 100/5 = 20 for the second bank.

◼ If both banks earned 1% on assets (ROA = 1%), the first

bank would report a ROE of 10% while the second
bank’s ROE would equal 20%.
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◼ If each bank reported a ROA equal to -1%, the second
bank’s ROE would equal to -20% or twice the loss of the
first bank.

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THE RETURN ON EQUITY: ROE

◼ From its first-level decomposition, it is seen

that in order to report high ROE at least one
of the following must be true:
– The bank is taking one more risk
– The bank is realizing cost advantages
compared to peers

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 THE RETURN ON EQUITY: ROE

◼ ROE = NI/E = NI/TA * TA/E = ROA * EM

◼ ROA can be broken into 2 component parts as follows:

ROA = NI/TA
ROA =(NI/Total Operating Income )* (Total Operating Income/TA)
ROA = PM*AU

◼ PM: Profit margin, net income generated per unit of total

operating income ( interest and non interest income). It
measures the bank’s ability to control expenses.
◼ AU: Asset utilization ratio measures the extent to which
the bank’s assets generate revenues.

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 THE RETURN ON EQUITY: ROE

◼ A breakdown of PM can isolate the various expense

items listed on the income statement as follows:

◼ PM = NI/Total Operating Income

◼ PM = (II + NOII - IE - NIE – P - T)/Total Operating Income
◼ PM = II/TOI + NOII/TOI - IE/TOI - NIE/TOI - P/TOI - T/TOI
◼ PM = (II+NOII)/TOI - IE/TOI - NIE/TOI - P/TOI - T/TOI
◼ PM = TOI/TOI - IE/TOI - NIE/TOI - P/TOI - T/TOI

PM = 1 - IE/TOI - NIE/TOI - P/TOI - T/TOI

The lower any of these expenses ratio the higher the

bank’s profitability
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Typical Income Statement

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 THE RETURN ON EQUITY: ROE
Other decomposition of ROA:
◼ ROE = NI/E = NI/TA * TA/E = ROA * EM
◼ ROA = NI/TA = (TOI –Total expenses)/TA
◼ ROA = AU – ER
◼ ER: Expense Ratio
◼ The lower is the ER , the more efficient a
bank will be in controlling expenses.
◼ The ROA analysis can decompose owner’s
returns into cost management and revenue
management.

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 THE RETURN ON EQUITY: ROE

The break down of AU ratio into interest income

and non interest income ratios:

◼ AU = TOI/TA = (II + NOII)/TA = II/TA + NOII/TA

◼ AU = interest income ratio + non interest income
ratio

Remember that:
ROA = AU – ER
ROA = PM*AU
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 OTHER PROFITABILITY MEASURES

◼ Net Interest Margin (NIM) measures the net return on

the bank’s earning assets:

NIM = NII/Earning Assets

NIM = (II - IE)/(Inv. Securities + Net Loans and Leases).

◼ Generally, the higher this ratio is, the better is. But it
cannot measure the risk for the bank.

◼ Assume that we replace the earning assets with higher

earning ones but riskier, the NIM will increase but it also
increases the risk for the bank.

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 OTHER PROFITABILITY MEASURES

◼ The spread: this ratio measures the difference between

the average yield on earning assets and average cost of
interest bearing liabilities:

◼ Spread = (II/earning assets) – (funding cost/ interest

bearing liabilities)

◼ Generally the higher the spread, the more profitable the

bank but again the source of high spread can involve a
higher risk for the bank.

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 OTHER PROFITABILITY MEASURES

◼ Overhead Efficiency: this ratio measures the

bank’s ability to generate non interest income to
cover non interest expenses.
◼ Overhead Efficiency = NOII/NIE
◼ The higher this ratio, the better.
◼ Generally NIE >NOII, therefore this ratio is <1.

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 OTHER PROFITABILITY MEASURES

◼ Efficiency ratio : measures the bank’s ability to manage

costs
Efficiency ratio = NIE/TOI

◼ It indicates how much the bank pays for its non interest
expenses for 1 unit of Total Operating Income.
◼ The bank uses this ratio to measure the success of
recent efforts to control non interest expenses while
supplementing earnings from increasing fees.
◼ The smaller is the efficiency ratio the more profitable is
the bank.

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 OTHER PROFITABILITY MEASURES

◼ Burden ratio: measures the amount of non interest

expense covered by fees, service charges and other
income as a fraction of average total assets.

Burden ratio= (NIE – NOII)/TA

◼ The greater is this ratio the greater non interest expense

exceeds non interest income for the bank’s balance
sheet size. The bank is thus better off with a low burden
ratio

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 MARKET MEASURES OF BANK
PERFORMANCE

◼ Financial markets may be a measure of bank

performance.
◼ Equity markets: common stock and book-to-market ratio
measures market perception of growth potential and risk
assets.

Earning per share: EPS= NI/Number of stocks

Price to Earnings: P/E = Stock price/EPS

Market Value of equity: MV of Equity = MV of assets – MV of

Liabilities

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 MARKET MEASURES OF BANK
PERFORMANCE

◼ Return to stockholders : (stock price t - stock price t-

1+dividends) /stock price t-1

◼ Example: you buy 100 shares of LOKA Bank at the

beginning of 2013 for 45.06, the bank paid 2 per share in
dividends. At the beginning of 2014, the stock price was
33.02.

◼ Return to stockholder in 2014 ? (-22,28 %)

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 NON FINANCIAL MEASURES

◼ Non-financial measures provide valuable insights into

various aspects of a bank's operations, customer
satisfaction, and overall effectiveness. Some common
non-financial measures used to evaluate bank
performance include:
1.Customer Satisfaction: Surveys, feedback
mechanisms, and customer retention rates can gauge how
satisfied customers are with the bank's products, services,
and overall experience.
2. Quality of Service: Metrics such as average wait times,
response times to customer inquiries or complaints, and
accuracy of transactions can assess the quality of service
provided by the bank.
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3. Employee Satisfaction and Engagement: Employee
turnover rates, employee satisfaction surveys, and
measures of employee engagement can indicate how
satisfied and engaged employees are, which can impact
customer service quality and overall performance.

4. Operational Efficiency: Measures such as transaction

processing times, branch productivity, and cost per
transaction can assess the efficiency of the bank's
operations.

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5. Innovation and Technology Adoption: Assessing the
bank's ability to innovate and adopt new technologies
through measures such as the number of new products or
services introduced, investments in technology
infrastructure, and adoption rates of digital banking
channels.
6. Community Impact and Corporate Social
Responsibility: Assessing the bank's contributions to the
community, environmental sustainability initiatives, and
adherence to corporate social responsibility (CSR)
practices can demonstrate its commitment to social and
environmental stewardship.
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◼ By incorporating non-financial measures alongside
traditional financial metrics, banks can gain a more
comprehensive understanding of their performance and
make more informed strategic decisions to drive long-
term success.

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