Bank Performance Metrics
Chris Blake
Director
After watching this video, you will be able to evaluate a range of financial measures and metrics used by investors to assess banks. You will understand that banks, especially in the private sector, need to generate sufficient returns both to reward their investors and to grow their own capital resources.
After watching this video, you will be able to evaluate a range of financial measures and metrics used by investors to assess banks. You will understand that banks, especially in the private sector, need to generate sufficient returns both to reward their investors and to grow their own capital resources.
Bank Performance Metrics
10 mins 50 secs
This video describes a number of metrics commonly used to describe the financial performance of banks and why this is important.
Key learning objectives:
Evaluate a range of financial measures and metrics used by investors to assess banks
Compare and contrast Net Interest Margin (NIM) with other performance measures
Discuss those performance measures which capture credit risk
What is NIM and how is it calculated?
Net Interest Margin, or NIM, is the basis of profitability in many banks and can be somewhere between 50-80% of revenues. It is calculated by dividing Net Interest Income by Average Interest-Bearing Assets. Net interest income is simply the interest a bank receives on loans and bonds less interest paid on deposits and debt issuance.
NIM being downward is likely to be caused by three major components. What are they?
- The underlying level of interest rates
- Increased number of banks and competition in the market
- Reduced cost of technology
How much does it cost to run a bank?
One of the easiest to understand and most commonly used metrics is the Cost to Income Ratio, which expresses operating cost as a percentage of total income. Operating costs cover staff costs, premises costs and IT costs, but not bad debt. In essence this metric measures the operating efficiency of the business.
Sometimes banks like to show they are becoming more efficient, and a favourite metric for showing this is what is called JAWS: the % increase in income minus the % increase in costs.
What are the losses caused by Non-performing loans?
Banks lose some money as a result of customers defaulting on loans. Banks understand there is a level of expected losses. They carry out expected-loss modelling to account for this. Actual losses can undershoot or overshoot model outputs. But, however these losses come about, we would call them losses caused by Non-performing Loans (NPL).
What is ROTE and why is it favoured by the management?
Return on Tangible Equity is Net Profit after Tax divided by Average Tangible Equity, expressed as a percentage. It is favoured by management as they cannot control intangibles (for example the money that may have already been spent on goodwill) and, due to its reasonable correlation with Return on Equity, it is of interest to shareholders, it therefore helps align interests and reduce the Principal/Agency problem of Shareholders versus Management.
What is Tangible equity?
Tangible equity is total equity in the balance sheet, essentially made up of share capital and reserves, less any intangible assets such as goodwill or deferred tax assets.
Chris Blake
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