CHAPTER : 5

Bank Fund Management

Measuring & Evaluating Bank

Performance
Peter Rose, Commercial Bank Management

MD. LUTFOR RAHMAN

Determining the Banks Long-Range Objectives

The first step in analyzing banks financial performance
is to decide what objectives the bank is or should be
seeking. 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 &
stockholders have chosen.

Maximizing the Value of the Firm/Bank

Expected Stream of Future
Stockholders Dividends

Value of the Banks Stock =

Discount factor (the minimum

Required market rate of return on

Equity capital)
The minimum acceptable rate of return (r) is sometimes referred
to as banks Cost of Capital & has two main components:
1. The Risk-Free Rate of Interest.
2. The Equity Risk Premium.

Maximizing the Value of the Firm/Bank---Contd

The value of the banks stock (P0) will tend to rise in

any of the following situations:
1. The value of the stream of future stockholders
dividends is expected to increase.
2. The banking organizations perceive level of risk has
fallen, due perhaps to an increase in the bank's
capital reserves. A decrease in its loan losses, or the
perception of investors that the bank is less risky
overall & therefore, has a lower equity risk
premium.
3. Expected dividends increases are combined with
declining risk, as perceived by investors in the
banks stock.

Stock Price Determination of Bank

One-Period Model:
D1

P0 =

r-g

r = rate of return
g = growth rate of dividend

Multiple Period Model:

P0

D1
(1 + r)

D2

Dn

+ ---- +

(1 + r)2

(1 + r)n

Pn
(1 + r)n

Profitability Ratios
Return on Equity (ROE) = Net Income After Tax / Total Equity
Capital
Return on Assets (ROA) = Net Income After Tax / Total Assets.
Net Interest Margin = (Interest income from loans & security investments
Interest expenses on deposits & on other deposits) / Total
Assets
Net Noninterest Margin = (Noninterest Revenues Noninterest Expenses) /
Total Assets
Net Bank Operating Margin = (Total Operating Revenues Total Operating
Expenses) / Total Assets
Earnings Per Share (EPS) = Net Income After Tax / Common Equity
Shares Outstanding

Interpreting Profitability Ratios

1.

2.

3.

The Banks Net Profit Margin (NPM):

Net Income / Total Operating revenues
Effectiveness of expenses management (cost control) & service
pricing policies.
The Banks degree of Asset Utilization (AU):
Total Operating revenues/TA
Portfolio management policies, especially the mix & yield on
the banks assets.
The Banks Equity Multiplier (EM):
TA/Total Equity Capital
Leverage or financing policies, the sources chosen to fund the
bank (debt or equity).
ROE = NPM x AU x EM

Interpreting Profitability Ratios.. Contd

1. Tax Management Efficiency = Net Income / Net

Operating Income before taxes
2. Expense Control Efficiency = Net Operating Income
before taxes / Total Operating Revenues
3. Asset Management Efficiency = Total Operating
Revenues / Total Assets.
4. Funds Management Efficiency = Total Assets / Total
Equity Capital
ROE = Tax management efficiency X Expense
management efficiency X Asset management
efficiency X Funds management efficiency.

Efficiency Ratio
Operating Efficiency Ratio =
Total Operating Expense/Total Operating Revenues

Employee Productivity Ratio =

Net Operating Income/Number of Full-time Employee

Measuring Risk in Banking

1.
2.
3.
4.

5.

Credit Risk: The danger of default by a borrower to whom a

bank has extended credit.
Liquidity Risk: The danger of having insufficient cash to
meet a banks obligations when due.
Market Risk: The danger of changing market values of bank
assets, liabilities & equity that may bring about loss.
Interest Rate Risk: The danger that shifting interest rates
may adversely affect a banks net income, the value of its
assets or equity.
Earnings Risk: The danger that a banks rate of return on
assets or equity or its net earnings may fall.

Measuring Risk in Banking..Contd

6.

Solvency Risk: The danger that a bank may fail due to

negative profitability & erosion of its capital.
7. Inflation Risk: The probability that an increasing price level
for goods & services will unexpectedly erode the purchasing
power of bank earnings.
8. Exchange Rate Risk: The fluctuations in the market value of
foreign currencies will create losses for the the bank by
altering the market values of its assets & liabilities.
9. Political Risk: The changes in government laws or
regulations will adversely affect the banks earnings,
operations & future prospects.
10. Crime Risk: The possibility that bank owners, employees, or
customers may choose to violate the law & subject the bank to
loss from fraud, embezzlement, theft or other illegal acts.

Problems to be done:
1.Stock brokers have projected that ABC Bank will pay a dividend BDT 180 per
share on its common stock at the end of the year. The risk-adjusted cost of capital
is 18 percent. If an investor plans to hold that stock for only four years and hopes to
sell it at a price of BDT 14,500 per share, what should the value of the bank's 7,000
stocks be in today's market? Cumulative Growth rate of ABC Banks dividend each
year is 5%.
2. Southern bank has following information. Please Calculate: a) Net interest
margin b) Net operating Margin
c) Net non interest margin d) Earnings per
share
e) ROE
BDT in
Million

BDT in Million

Interest expenses

145

Non Interest Income

132

Noninterest expenses

78

Retained Earnings

36

Current assets

365

Provision of loan losses

24

Securities gains

25

Fixed Assets

Paid up capital

5,450

Interest Income

278

Share premium

12

Minority Interest

18

Taxes

Deferred Tax

19

Shares of Common stock outstanding

350,000

4,565

Problems to be done:
3. Using this information for North South bank, calculate the bank's net
interest margin, non interest margin, and ROA.

BDT in
Million
Extraordinary income
Fixed Assets

129
4,250

BDT in
Million
Provision of loan losses

64

Interest Expenses

79

Noninterest expenses

87

Interest Income

217

Securities gains

65

Current assets

1,301

Non Interest Income

128

Taxes