17-Feb-23

Lecture 02
Evaluating Bank Performance

Bank Financial Statements

• Like other financial intermediaries, commercial banks facilitate the flow of funds
from savers to borrowers
• Their financial characteristics largely reflect government-imposed operating restrictions
• Three unique characteristics of commercial banks are:
1. Because their function is primarily financial, most banks own few fixed assets and thus
exhibit low operating leverage
2. Most banks’ liabilities are payable on demand or carry short-term maturities, so depositors
can renegotiate deposits rate as market interest rate changes
3. Bank operates with less equity capital which increases financial leverage and the volatility
of earnings

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Bank’s Financial Statement: Balance Sheet

Bank Liabilities and
Bank Assets Stockholders’ Equity
• Loans • Transactions accounts
• Investment securities • Savings and time deposits
• Noninterest cash and due from • Other borrowings
banks • All common and preferred capital
• Other assets

Bank’s Financial Statement: Income Statement

• Interest income
• Interest expense
• Net interest income
• Noninterest income
• Noninterest expense
• Burden
• Provisions for loan and lease losses
• Realized securities gains or loss
• Pretax net operating income
• Applicable income taxes
• Net income

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Analyzing Bank’s Financial Statement

• Traditional models of bank performance:
• Return on asset (ROA) approach
• CAMELS rating models
• Key Performance Indicators (KPI)
• Some other sophisticated models

Decomposition of Return on Equity: Nature

of Bank Profits
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒
𝐴𝑣𝑔 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

𝑁𝑜𝑛𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒
Expense
𝐴𝑣𝑔 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
Ratio

Return on Tax Ratio 𝑃𝑟𝑜𝑣𝑖𝑠𝑖𝑜𝑛𝑠 𝑓𝑜𝑟 𝐿𝑜𝑎𝑛 𝐿𝑜𝑠𝑠𝑒𝑠

𝐴𝑣𝑔 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

Return on Assets
Equity Equity
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝐴𝑣𝑔 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
Multiplier Asset
Utilization 𝑁𝑜𝑛𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝐴𝑣𝑔 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

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CAMELS Rating
• Capital adequacy
• Asset quality
• Management quality
• Earnings
• Liquidity
• Sensitivity to market
risk
Rating Analysis Interpretation
1.0 – 1.4 Strong: sound in every respect, no supervisory
responses required
1.6 – 2.4 Satisfactory: fundamentally sound with modes
correctable weakness
2.6 – 3.4 Fair: combination of weakness if not redressed will
become severe
3.6 – 4.4 Marginal: immoderate weakness unless properly
addressed could impair future viability of the bank
4.6 – 5.0 Unsatisfactory: high risk of failure in the near term

Key Performance Indicators for Banks

• KPIs focus on some controllable factors such as:
• Operating efficiency
• Expense control
• Tax management
• Liquidity
• Risk

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Alternative Models
• Measures based on Total Operating Revenue
• Stock market-based performance measure
• Customer-centric performance measure
• A ‘Risk-Index’- based approach

Any Question?
Thank you.