BANK

MANAGEMENT
CHAPTER 4
MEASURING AND
EVALUATING BANK
PERFORMANCE

INTRODUCTION

Banks today are under great pressure to

perform to meet the objectives of their
stockholders, employees, depositors,
and borrowing customers, while
somehow keeping government
regulators satisfied that the banks
policies, loans, and investments are
sound.

Cont

Commercial bank is simply a

business corporation organized for
the purpose of maximizing the value
of the shareholders wealth invested
in the firm at an acceptable level of
risk
Thus, this topic centers on the most
important performance dimensions
for any bank profitability and risk.
3

Cont

Performance refers to how adequately a bank

meets the objectives of its stockholders
(owners), employees, depositors, and other
creditors.
At the same time, these financial institutions
must find a way to keep government regulators
satisfied that their operating policies, loans and
investments are sound, protecting the public
interest.
The success of these institutions in meeting the
expectations of others is usually revealed by a
careful and thorough analysis of their financial
statements.
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EVALUATING BANK
PERFORMANCE
1.
2.

Internal performance
External performance

Internal Performance
1.

2.
3.

4.

Bank planning Objectives,

Budgets, Strategies
Technology
Personal Development training,
incentives
Bank condition - CAMELS

Cont

Determining the banks long-range

objectives
Bank performance must be directed
toward specific objectives
A fair evaluation of any banks
performance should start by evaluating
whether it has been able to achieve the
objectives its management and
stockholders have chosen

Cont

Maximizing the value of the firm

A key objective for any bank
Maximize a banks stock value
All banks are corporation, with stockholders
interested in the value and yield of their
stock
If the stock fails to rise in value
commensurate with stockholder
expectations, the investors may seek to
unload their shares and the bank will have
difficulty in raising new capital to support its
future growth

Cont

Formula:

P0 = D1
---------------------

rg
P0 = value of the banks stock
D1 = expected dividend on stock in period 1
r = rate of discount reflecting the perceived
level
of risk attached to investing in the stock.
g = expected constant growth rate of dividend
9

Cont

The value of the banks stock will tend to

rise in any of the following situations:
The value of the stream of future stockholder
dividends is expected to increase, due perhaps
to recent growth in some of the markets served
by the bank or because of profitable
acquisitions the banking organization has made
The banking organizations perceived level of
risk has fallen, due perhaps to an increase in
capital or a decrease in loan losses
Expected dividend increases combined with
declining risk, as perceived by investors in the
banks stock

10

Cont

Recent evidence has found that

stock values to be especially
sensitive to changes in:
Interest rates
Currency rates
The economic conditions that the bank
serves

11

Cont
CAMELS

C
A
M
E
L
S

Capital adequacy
Asset quality
Management quality
Earning/profitability
Liquidity
- Sensitivity to market risk
12

Cont
Capital adequacy reduce risk, absorb
losses, support the financing & operation
of a bank, provide protection to
depositors & other creditors, public
confidence.
Asset quality determining the current
and future profitability of the bank.
- Loans exhibit the highest default rates,
hence, if NPLs increase, the asset quality
of a bank will deteriorate.

13

Cont

Management quality the

management has an overview of a
banks operations, manages the
quality of loans & has to ensure that
the bank is profitable.
Profitability The most important
indicator of bank performance. The
popular ratios: ROA, ROE, and net
interest margin.
14

Cont

Liquidity to meet deposit withdrawals

and satisfy customer loan demand.
Liquidity refers to how fast and easy an
asset can be converted into cash.
If a bank suffers financial distress for
any reason, asset liquidity can be a
reserve that the bank can draw on in
the event its access to purchased funds
is reduced.
15

Cont

Sensitivity to market risk

Market risk changes in the
interest rate that might affects the
market value of a security

16

External Performance
1.

2.

3.

Market Share equity/earnings,

technology
Regulatory compliance capital,
lending
Public confidence deposit
insurance, public image

17

Evaluating Bank
Performance

Profitability Ratios: A Surrogate for

Stock Values
Firm performance stock price is the best
indicator because it reflects the markets
evaluation
This indicator is not reliable in banking
Most bank stock, especially stock issued
by smaller banks, is not actively traded in
international or national markets
Thus, banking institutions used
profitability ratios as surrogates to
market value indicators
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Key Profitability Ratios in

Banking

Return on Equity (ROE)

Return on Assets (ROA)
Net Interest Margin
Net Noninterest Margin
Net Bank Operating Margin
Net Returns Prior to Special
Transactions (NRST)
Earnings Per Share of Stock (EPS)
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Key Profitability Ratios in

Banking

Return on Equity (ROE)

Net income after taxes
Total equity capital
ROE is a measure of the rate of return
flowing to the banks shareholders
It approximates the net benefit that the
stockholders have received from
investing their capital in the bank (i.e.,
placing their funds at risk in the hope
of earning a suitable profit)
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Cont

Return on Asset (ROA)

Net income after taxes
Total assets
ROA is primarily an indicator of
managerial efficiency
It indicates how capably the
management of the bank has been
converting the institutions assets
into net earnings
21

Cont

Net operating margin, net interest

margin and noninterest margin are
efficiency measures as well as
profitability measures
The measures indicate how well
management and staff have been able to
keep the growth of revenues (which
come primarily from the banks loans,
investments and service fees) ahead of
rising costs (principally the interest on
deposits and money market borrowings
and employee salaries and benefits)
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Cont

Net Interest Margin

(Interest income from loans and security
investments Interest expense on deposits
and on other debt issued)
__________________________________________
Total assets

Measures how large a spread between interest

revenues and interest costs management has
been able to achieve by close control over the
banks earning assets and the pursuit of the
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cheapest sources of funding

Cont

Net noninterest margin

(Noninterest revenues Noninterest
expenses)
Total Assets

Measures the amount of noninterest revenues

stemming from deposit service charges and other
service fees that bank has been able to collect (fee
income) relative to the amount of noninterest costs
incurred (including salaries and wages, repair and
maintenance costs on bank facilities, and loan-loss
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expenses)

Cont

For most banks, the noninterest margin is

negative, noninterest costs generally
outstrip fee income, though bank fee
income has been rising rapidly in recent
years as a percentage of all bank
revenues

25

Cont

Net bank operating margin

(Total operating revenues Total operating expenses)
Total assets

26

Cont

Net returns prior to special transactions

(NRST)
(Net income after taxes and prior to security gains (or
losses) and other extraordinary items)
_____________________________________________________________________________________

Total assets

Measure the banks income from routine,

recurring sources of revenue, including
revenues generated by loans, investments,
and fees from selling other financial services
(such as checking accounts), relative to the
banks total resources (assets)
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Cont

Earnings per share of stock (EPS)

Net income after taxes
common equity shares
outstanding

Provides a direct measure of the returns

flowing to the banks owners, its
stockholders-measured relative to the
number of shares sold to the public
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Cont

In an effort to maximize profitability and

the value of the shareholders investment
in the bank, greater efficiency is vital
Efficiency reduce operating expenses
and increase the productivity of bank
employees through the use of automated
equipment and improved employee
training
Among the most revealing measures of a
banks operating efficiency and employee
productivity are:
29

Cont

Operating Efficiency Ratio

Total operating expenses
Total operating revenues

Employee productivity ratio

Net operating income
___________________________________________________________________________________________________________________

Number of full-time-equivalent
employees
30

Cont

Hang Sengs cost efficiency ratio for

2014 was 31.8% among the lowest in
the banking world.

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WHY BANKS FAIL?

1.

Recent studies have identified a few factors that

most failing banks seem to have in common.
Problem in their loan portfolio
- Banks have inadequate systems for spotting
problem loans early.
- Overlending in which borrower receives
larger loans than they can carry.
- Concentrating loans in one industry or in a
single group of businesses.
- Dont follow their own loan policies.
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Cont
2. Economy
- Economic decline, with rising unemployment,
sluggish sales, and increasing business
failures.
- Banks that control their expenses well and
find ways to reach into other market areas are
not experiencing economic decline.

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Cont
3. Leadership problems
- BOD may lack knowledge of banking and
play only passive role in overseeing the
bank.
- Mistake and lack of scruples among senior
managers who may not be capable and
honest.

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Cont
4. Expense control problems
- Invest the banks money in lavish offices
and enjoy handsome fringe benefits that
the banks earning cannot support.
5. Audit and control procedures

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THE IMPACT OF BANK SIZE ON

PERFORMANCE

When the performance of one bank is compared to

another, bank size usually measured by total assets or
total deposits become a critical factor. Most of the bank
performance ratios are highly sensitive to the size group
in which a bank falls
In terms of balance-sheet ratios, many of which reflect the
various kinds of risk exposure banks face, the smallest
banks usually report higher ratios of equity capital to
assets, while the largest, billion-dollar-plus institutions
usually have much thinner capital-to-assets ratios
36

Cont

Some bank analysts argue that larger banks

can get by with lower capital-to-assets
cushions because they are more diversified
across many different markets and have more
risk-hedging tools at their disposal. Smaller
banks appear to be more liquid, as reflected
in their lower ratios of total loans to total
deposits, because loans are often among a
banks least liquid assets
37

Cont

However, the biggest banks hold larger

proportion of cash assets relative to total
assets because they hold the deposits of many
smaller banks. The biggest banks also appear
to carry greater credit risk as revealed by
their higher loan-loss ratios.

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