Analyzing Bank Performance

Analyzing bank performance

Main objective of main performance analysis

1 Due to the inherent rick-reward trade-off in banking and finance, there is a close link between risk taking and profitability. Similar to many other business. The objective profit-maximizing bank will be to add value to the bank equity by maximizing risk-adjusted return to SHs. Risk taking is a double-edged sword. However, for banks, profitability and SH value add will depend on the efficiencies of risk management processes in optimizing the risk-reward trade-off. Risk taking is intended to generate higher expected earning, but it can also translate into actual loss.

2. the main objective of bank performance analysis is to evaluate progress towards meeting the foals and objectives set out by management and to compare a bank’s performance relative to other banks. Generally, bank performance evaluation involves the analysis of financial statement (bank’s balance sheet and profit and loss amount) and accounting ratios that identify key components of performance. In accessing bank performance, it’s important to distinguish between bank policy decisions which affect performance and external factors which are beyond the control of bank management. The analysis of performance aims to point out the strength and weakness in other for management to take appropriate action.

Regulation ratings

3. Regulations on several counties rate bank’s performance according to general categories of performance under the label of CAMELS. This refers to the following.

First. Capital adequacy. This relates to the bank’s ability to maintain adequate capital. To obtain adequate capital. Means to matte the bassel committee of capital requirement, which requires at least 8% of total risk-based capital ratio in based I accrual. Secondly, assets quality ,refers to the amount of existing credit risk associated with the loan and investment portfolio and off-balance sheet activities.

Thirdly, management quality reflects the ability of the directors and management to identify. Measure. Monitor, and control risks. Regulations emphasis the existence and use of policies and their levels and trend and sustainability or quality of earnings. Fifth, liquidity and lashy, sensitivity to market risk, this sensitivity examines. How sensitivity to market risk, may adversely affect a bank’s earnings or economic capital.

Regulations rates on a scale of 1(highest) to 5(lowest) within the above 6 categories and then to make up an overall composite rating which is the average across categories. According to the ratings, banks with a rating of four or above are considered to be particularly problematic and will be closely monitored. Since their risk level is perceived as very high. This rating system is essentially a screening device for regulars to identify problem banks and spot troubles in advance.

Accounting and market value measures of performance

4. Another important measurement method is through calculating accounting ratio. Accounting measures of earnings provide profitability information base on contribution margins calculated at various levels of the bank’s income statement .Levels and stability of earnings measures should be a focus for management policies.

From the bank’s income statement, we can get:

1. Operating income = interest margin+ fee income – operating costs

2. Net income = operating income – preparation – provision- tax

Although net income is an indicator of how well a bank performs, it doesn’t adjust fot the size of the bank, and hence makes of diffivult to compare one bank relative to another. For example, a net income of 100m, may not be large income to a large bank, but it’s sufficiently large for a small bank. The drawback of analyzing bank performance ratio in isolation is that the figure may not be meaningful if the comparisons are not made with a benchmark ,or peer group or competitors and given time frame. Such accounting ratios are frequently used to attempt to predict corporate bankruptcy and as early warning system.

Several traditionally used profitability measures, many of which are bared on ratios of accounting variables.

For example: Return on equity(ROE)= Return on Assets(ROA) * Equity MUtiple(EM)

ROE is the ratio of net income to equity, which is different from investment return that are measured by dividend and capital gain in share price.

ROA is the ratio of net income to total value of assets. This gives information on how