Analyzing Bank Performance PDF

A N A LY Z I N G B A N K PERFORMANCE Dr. M. Ali WHO NEEDS TO KNOW ABOUT BANK PERFORMANCE AND WHY: The bank itself - needs to know about its own performance - e.g. to set bonuses! Shareholders : want to know how well the bank is performing. Expect manager to give info about it....

A N A LY Z I N G B A N K PERFORMANCE Dr. M. Ali WHO NEEDS TO KNOW ABOUT BANK PERFORMANCE AND WHY: The bank itself - needs to know about its own performance - e.g. to set bonuses! Shareholders : want to know how well the bank is performing. Expect manager to give info about it. Bondholders - have 'skin in the game' - if bank goes bust, they lose their money, so like to keep an eye on the bank in which they've invested. No voting rights, not owners etc, just lent money to bank. Investors in shares/bonds issued by the bank, and bank managers and other employees, have an obvious economic and strategic interest in the current and future prospects of the banking firm.  Competitor banks (may include takeover firms hungry for acquisition) - always comparing themselves to other banks! They want to rank themselves in the market. Might have individuals who want to take over banks, so necessary for mergers and acquisitions to take place. Direct competitors - peer group analyses compare profitability of similar banking institutions operating in similar operating env, in some cases, the homogeneity of the groups being analyzed, allows for the use of sophisticated statistical techniques. Financial markets (LT capital and ST money markets) LT capital markets -want to know what prices to charge the bank. Money markets - if they hear there's poor performance by Northern Rock, they want to pull out from lending to them. Capital and money market participants use ratio analysis to monitor the performance of banks - they need to assess the creditworthiness of the banks they're lending to. Money market participants (esp those that lend in the interbank market), need to assess creditworthiness of banks they're lending to. Deterioration in bank performance= increases credit risk= interbank lenders need higher returns on their loans. Banks with higher capital ratios= likely to get cheaper finance in interbank markets, as seen as less risky. Regulators - act on behalf of taxpayers and the public - these are two diff groups. Regulators -Public= everyone in society. Taxpayers only make up 65% of society. If all banks in UK go bust and have to be bailed out by gov, it's the taxpayers who are paying for this, not everyone! Regulators monitor banks, to try to prevent bank failures, so they must get info about bank performance. Domestic and international regulatory authorities. Fin regulators evaluate solvency, liquidity and overall performance of banking firms, to assess likelihood of potential problems. Competition authorities - look at bank performance indicators - analyze if banks are making excess profits and acting uncompetitively. Depositors - you and me. Could be retail depositors, or wholesale depositors - if bank goes bust, wholesale depositors lose their money, so they need to know about bank performance. General people, even though they have deposit insurance, still want to know what's going on - if Barclays was going down, we'd want to know. Depositors must ensure the bank remains profitable and doesn't expose itself to too much risk. Credit rating agencies - play a pivotal role in regulation. Their access to performance is v important. They rate banks, no bank in Europe or North America has a triple Aaa rating. Most banks are rated single A, or lower. If their rating is low, their cost of borrowing is high, and if they can't pass this onto customers, it gives them a headache. o e.g. Moody's, Standard & Poor's and Fitch IBCAA - analyses performance info, to compile analyses and ratings of banks operating in certain country/group of countries. A C C O U N T I N G A N D M A R K E T VA L U E M E A S U R E S O F PERFORMANCE Accounting measures of earnings provide profitability info based on contribution margins calculated at various levels of bank's income statement. In US, banks have to publish quarterly, and annually in the UK. People watch for any of these accounting measures, to see if they're stable. In order to deduce whether a bank is managing itself well or has become risky and is in decline. The level and stability of these measures should be the focus for risk management policies. These components are necessary to calculate the measures of risk performance. Operating income= interest margin+ fee income - operating costs Fee income - all the fees the banks charge Operating costs - staff salaries, building etc. Net income = operating income - depreciation - provisions (for losses) - taxation  Bank performance is calc using financial ratio analysis and assessed by looking at past and current trends, and determining future estimates of bank performance - looks at diff areas of bank performance - e.g. profitability, asset quality and solvency. Key performance indicators (KPls) = factors by reference to which the development, performance or position of the bus of the comp can be measured effectively (Companies Act, 2006). Can be fin/non-fin (e.g. customer satisfaction), must be monitored/reviewed by management, considering the camp's strategic obj. Info for calc performance are taken from period fin reports produced by the accounting system - b/s and income st.  P R O F I T A B I L I T Y RATIOS ROE (Return on Equity): Most important indicator of bank's profitability and growth potential. It's the return to S/H, or the% return on each £ of equity invested in the bank. Calculated as: Ratio of net income to equity. Accounting ROE - can be misleading in cases where its value is high, as the bank has inadequate equity capital. Barclays - ROE of 24.7% for 2006, (and only 4.5% in 2013) This is a simple measure - most popular measure. Can demonstrate massive returns for shareholders. o Crucial risk elements are missing in ROE, e.g. the proportion of risky assets and level of solvency. o Fails to distinguish best performing banks from others, as it's only a ST indicator= can't measure potential for sustainable (LT) results of the bank. R O A ( R E T U R N O N ASSETS) Ratio of net income, to total value of assets - tells us how much net income is generated per£ of assets. Provides info on how efficiently a bank is being run, as it indicates how much income is generated on average per currency unit of assets. Normally indicates if bank's performance is below par, but doesn't tell you the reason for poor performance. o Doesn't tell us why it's bad, just tells us that it's bad. Barclays - ROA of 0.4% for 2006 (same as prev year). o Return on assets of 0.4% - one reason why chief execs never announce ROA, cos it's always a small figure! You wouldn't impress shareholders with this figure! Benchmark figure= 1% T W O A L T E R N A T I V E W A Y S T O C A L C R O E A N D ROA ROE= ROA x EM ROA= PM xAU Where: o EM - equity multiplier (assets/equity), a measure of bank's leverage - measures the extent to which a bank's assets are funded with equity, relative to debt. o PM - profit margin (net income/operating income). o AU - asset utilisation (operating income/assets). Operating income = interest margin + fee income - operating costs Net income = operating income - depreciation - provisions - tax M A R K E T T O B O O K R A T I O (M/B) Ratio of bank's market value per share, to its book value per share - i.e. ratio between market prices of bank's shares, and accounting value of S/H's equity per share. The lower the number, the better for investors. E.g. if bank's current share p = £4, and S/H's equity per share= £2, investors are ready to pay for one share twice the book value. Trying to see if the book value (the value on the accounts), is diff from the market value of the bank. A value >1 = bank is creating value.