Topic 4: Measuring

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Topic 4 Measuring Evaluating Commercial Banks
Performance

• Evaluating banks Performance
• The Impact of size on bank performance
• A banks performance can be measured in terms of
  its ability to meet up with the expectation of
  owners, employees, depositors, and borrowers.
• A banks performance can be evaluated by
  analysing some financial ratios from its
  financial reports Report of Condition (Balance
  Sheet) and Report of Income (Income Statement).
• Analysis of banks performance is usually based
  on the specific objective of the bank.

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• Specific Objectives and performance measurement
• Maximization of Value of firm maximization of
  value of stock
• Expected stream of future
• stockholder dividends
• value of stock (P0) Discounted factor (based
  on
• the minimum required market
• rate of return on capital given
• each banks perceived level of risk)
• where E(Dt) represents stockholder dividends
  expected to be paid in future periods, discounted
  by a minimum acceptable rate of return (r) tied
  to the banks perceived level of risk.
• r is often referred to as the institutional cost
  capital and it consists of two main components
  a) risk-free interest rate and b) equity risk
  premium.

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• Factors affecting value of Banks stock
• - Market growth and organisations profit
• - Perceived level of risk of bank
• - Fluctuations in market interest rate
• - Expected dividends increase or decrease.
• Profitability ratios A surrogate for stock
  value these include return on equity capital
  (ROE), return on assets (ROA), net interest
  margin (NIM), net non-interest margin (NNM), net
  operating margin (NOM), and Earnings per share of
  stocks (EPS).

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• Earning efficiency can also be measured in terms
  of earnings spread. Earnings spread is calculated
  as
• Earnings spread
• Total interest income Total interest
  expenses (10)
• Total earning assets Total
  interest-bearing
• bank liabilities

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• Importance of Closer Analysis of Profitability
  Ratios -
• it reflects
• - use of financial leverage (or the proportion
  of assets financed by debt as opposed to equity
  capital).
• - use of operating leverage from fixed assets
  (the proportion of fixed-cost input used to
  boost operating earnings as output grows).
• - ability to control operating expenses, such
  that additional revenue becomes net income
• - management of asset portfolio to meet
  liquidity needs without comprising returns from
  assets.
• - control of risk exposure, such that losses do
  not out- weight income and equity.

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• Risks in banking
• Banking risks can be described as the perceived
  occurrence of or uncertainty associated with an
  event it may relate to customers behaviour,
  stock prices movement, earnings or interest rate.
• Types of risk
• - credit risk, liquidity risk, market risk,
  interest rate risk, earnings risk, and capital
  risk.
• Components and measurement of banking risks
• A. Credit risk this is the risk associated
  with performance of a banks asset loans.
  Indicators or measurements of credit risk
  include
• - ratio of nonperforming assets to total loans
  and leases.
• - ratio of net charge-offs of loans to total
  loans and leases.
• - ratio of annual provision for loan losses
  to total loans and leases or to equity capital.

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• - ratio of allowance for loan losses to
  total loans and leases or to equity capital.
• - ratio of nonperforming assets to equity
  capital.
• - ratio of total loans to total deposits.
• B. Liquidity risk probability of not been
  able to meet customer withdrawals, loan demand,
  and other cash needs. Liquidity risk exposure
  can be measured in terms of
• - ratio of purchased funds (eurodollars,
  federal funds, security RPs, large CDs, and
  commercial paper) to total assets.
• - ratio of cash and due-from balances held
  at other depository institutions to total
  assets.
• - ratio of cash assets and government
  securities to total assets.
• C. Market risk this relates to market values
  of assets, liabilities, and net worth of banks.
  It is usually caused by changes in government
  policies, interest rate, currency prices
  (exchange rate), etc. Indicators of market risk
  are

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• - ratio of book-value assets to the
  estimated market value of those same assets.
• - ratio of book-value equity capital to the
  market value of equity.
• - market value of bonds and other fixed-income
  assets relative to their value as recorded on a
  bank s book.
• - market value of common or preferred stock
  per share, reflecting investor perceptions of a
  banks risk exposure and earnings potential.
• D. Interest rate risk uncertainty about
  movements in interest rate, which often affect
  profitability. Interest rate risk exposure can
  be measured in terms of
• - ratio of interest-sensitive assets to
  interest-sensitive liabilities.
• - ratio of uninsured deposits to total deposits
• E. Earnings risk uncertainty about
  fluctuations in net income after all expenses
  are covered. This may be due to internal or
  external factors. Earnings risk can be measured
  using
• - standard deviation (?) or variance (?2) of
  after-tax net income.
• - standard deviation (?) or (?2) variance of
  ROE and ROA.

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• F. Capital risk a banks long-run survival
  risk. This is usually due to stockholders
  reaction to excessive bad loans or loans losses.
  Capital risk can be measured by
• - interest rate spread between market yields
  on debts issues and the market yield on
  government securities of the same maturity.
• - Ratio of stock prices per share to annual
  earnings per share.
• - ratio of equity capital (net worth) to total
  assets
• - ratio of purchased funds to total
  liabilities.
• - ratio of equity capital to risk assets.
• Other forms of banking risk
• - inflation risk erodes the actual value of a
  banks income.
• - Currency or exchange rate risk alters
  market value of assets - or liabilities.
• - Political risk affects earnings,
  operations, and future - prospects.
• - Crime risk associated with default, fraud,
  embezzlement, theft, illegal acts.
• Note Read The Impact of size on bank performance