5-1

CHAPTER FIVE (4)

Measuring And Evaluating The
Performance Of Banks And
Their Principal Competitors
The purpose of this chapter is to discover what
analytical tools can be applied to FIs financial
statements so that >>
management and the public can identify the
most critical problems inside each bank and
develop ways to deal with those problems

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 5-2

Long-Range Bank Objective

Profit Maximization Vs Wealth
Maximization

Maximizing the value of the Firm: A key objective for

Nearly All Financial-Service Institutions
Basic goal of Financial Management: Maximizing
Shareholder’s Wealth
All financial firm's should purse this goal
Stockholders expectation counts
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Value of the Bank’s Stock

Value of Bank’s
Stock Expected stream of
 future
E(Dt)
P0   stockholders dividend

t  0 (1  r)
t
Discount Factor

Cost of capital (r) has two components:

•The risk free rate of return
•The equity risk premium
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Value of a Bank’s Stock Rises

When:
Expected Dividends Increase: Recent
growth>Profitable acquisition
Risk of the Bank Falls: Rise in equity
capital>Decrease in loan losses
Market interest rate decreases
Combination of Expected Dividend Increase
and Risk Decline

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Value of Bank’s Stock if Earnings

Growth is Constant
D1
P0 
r-g
Where,
D1= expected dividend on stock
r = rate of discount
g = expected constant growth rate

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 5-6

Key Profitability Ratios in Banking

Net Income After Taxes
Return on Equity Capital (ROE) 
Total Equity Capital

Net Income After Taxes

Return on Assets (ROA) 
Total Assets
Net Interest Income
Net Interest Margin 
Total Assets
Net Noninterest Income
Net Noninterest Margin 
Total Assets

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 5-7

Key Profitability Ratios in Banking

(cont.)

Total Operating Revenues -

Total Operating Expenses
Net Bank Operating Margin 
Total Assets

Net Income After Taxes

Earnings Per Share (EPS) 
Common Equity Shares Outstanding

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Name of the Ratio Calculation Description/comments

1. Return on equity Net income after taxes/ Rate of return flowing to the
capital Total equity capital shareholders
Net benefit that the stockholders have
received by investing their capital
2. Return on assets Net income after taxes/ The performance of the bank in
(ROA) Total assets converting assets into net earnings

3. Net interest Net interest income/ The ability of the management to

margin Total assets increase the spread between interest
revenue and interest costs
4. Net noninterest Net noninterest income/ The ability of the management to
margin Total assets increase spread between noninterest
income and cost
For most banks this is negative

5. Net operating Total operating revenue – Operating profitability compared to

margin Total operating expense/ total assets
Total assets

6. Earnings per Net income after taxes/ Earnings generated for shares
share (EPS) Common equity shares outstanding outstanding

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Breaking Down ROE

R O E = N e t I n c o m e / T o t a l E q u it y C a p it a l

ROA = E q u it y M u lt ip lie r =
N e t In c o m e / T o t a l A s s e ts x T o t a l A s s e t s / E q u it y C a p it a l

N e t P r o f it M a r g in = A s s e t U tiliz a t io n =
N e t I n c o m e /T o t a l O p e r a tin g R e v e n u e x T o t a l O p e r a t in g R e v e n u e / T o t a l A s s e ts

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ROE Depends On:

Equity Multiplier
Leverage or Financing Policies: Debt vs
Equity
Net Profit Margin
Effectiveness of Expense Management: Cost
Control
Asset Utilization
Portfolio Management Policies: Mix and
Yield on assets
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Components of ROE for All Insured

U.S. Banks (1991-2002)
Year ROE = NPM X AU X EM
2002 14.51 = 17.16 X 7.82 X 10.82
2000 14.48 = 12.20 X 9.32 X 12.74
1999 14.92 = 14.01 X 8.91 X 11.95
1997 11.94 = 13.32 X 8.86 X 11.94
1995 14.19 = 12.68 X 8.93 X 12.53
1993 15.13 = 13.47 X 8.87 X 12.66
1991 8.00 = 5.32 X 10.17 X 14.77

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 5-12

Measuring Risk in Banking and

Financial Services
Credit Risk
Liquidity Risk
Market Risk
Interest Rate Risk
Earnings Risk
Capital Risk

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Credit Risk

The Probability that Some of the

Bank’s/FIs Assets Will Decline in Value
and Perhaps Become Worthless

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Credit Risk Measures

Nonperforming Loans/Total Loans> Income generating assets
past due
Net Charge-Offs/Total Loans> Worthless loan and written off
Provision for Loan Losses /Total Loans> Annual Charges
Provision for Loan Losses /Equity Capital> Annual Charges
Allowance for Loan Losses/Total Loans> Total reserve
Allowance for Loan Losses/Equity Capital> Total reserve
Total Loans/Total Deposits> Ratio of the riskiest asset

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Liquidity Risk

Probability the Bank Will Not Have

Sufficient Cash and Borrowing Capacity to
Meet Deposit Withdrawals and Other Cash
Needs

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Liquidity Risk Measures

Purchased Funds/Total Assets> Federal

funds, Eurodollars, commercial paper
Net Loans/Total Assets>
Cash and Due from Banks/Total Assets
Cash and Government Securities/Total
Assets

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Market Risk

Probability of the Market Value of the

Bank’s Investment Portfolio Declining in
Value Due to a Rise in Interest Rates

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Market Risk Measures

Book-Value of Assets/ Market Value of Assets

Book-Value of Equity/ Market Value of Equity
Book-Value of Bonds/Market Value of Bonds
Market Value of Preferred Stock and Common
Stock per share

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Interest Rate Risk

The Danger that Shifting Interest Rates

May Adversely Affect a Bank’s Net
Income, the Value of its Assets or Equity

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Interest Rate Risk Measures

Interest Sensitive Assets/Interest Sensitive

Liabilities
Uninsured Deposits/Total Deposits> Govt.
and corporate Deposit

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Earnings Risk

The Risk to the Bank’s Bottom Line – Its

Net Income After All Expenses

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Earnings Risk Measures

Standard Deviation of Net Income

Standard Deviation of ROE
Standard Deviation of ROA

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Capital Risk

Probability of the Value of the Bank’s

Assets Declining Below the Level of its
Total Liabilities. The Probability of the
Bank’s Long Run Survival

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Capital Risk Measures

Stock Price per share/Earnings Per Share

Equity Capital/Total Assets
Purchased Funds/Total Liabilities> Money
market short term funds
Equity Capital/Risk Assets

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Other Forms of Risk in Banking

Inflation Risk
Currency or Exchange Rate Risk
Political Risk
Crime Risk

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Bank Performance Indicators Related to Size

2002
Under $100 $1 Bill.
All $100 Mill. To To $10 Over
Performance Indicators Banks Mill. $1 Bill. Bill $10 Bill.
ROA 1.37 1.05 1.26 1.48 1.38
ROE 14.85 9.55 12.89 14.69 15.57
Net Operating Margin/TA 1.33 1.03 1.25 1.45 1.33
Net Interest Margin/EA 4.13 4.32 4.44 4.32 4.03
Net Noninterest Margin/EA -1.03 -2.57 -1.29 -0.68 -2.16
Operating Exp./Operating Rev. 55.03 68.19 61.85 55.65 53.35
PLL/Net Charge Offs 127.22 123.08 151.26 173.24 118.51
Net Charge Offs/Total Loans 1.10 0.28 0.37 0.82 1.34
ALL/Total Loans 1.87 1.44 1.45 1.81 1.99
Noncurrent Assets + Real Estate/TA 0.96 0.88 0.75 0.73 1.04
Net Loans/TotalDeposits 87.61 72.37 78.92 89.10 90.25
Equity Capital/TA 9.24 11.12 9.91 10.29 8.84
Yield on Earning Assets 6.32 6.84 6.85 6.51 6.15
Cost of Funding Earning Assets 2.18 2.52 2.41 2.18 2.12
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Key Performance Indicator for FIs

Prices on common and preferred stock
Return on assets (ROA)
Net interest margin
Asset utilization ratio
Nonperforming assets to equity capital ratio
Book-value of assets to market-value of assets
Equity capital to risk-exposed assets
Earnings per share of stock
Return on equity capital (ROE)
Net operating margin
Equity multiplier
Cash account to total assets
Interest sensitive assets to interest sensitive liabilities
Interest-rate spread between yields on the financial firm’s debt and market
yields on government securities
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UBPR

The Uniform Bank Performance Report

Provided by U.S. Federal Regulators so
that Analysts Can Compare the
Performance of One Bank Against
Another

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