Analyzing Bank Performance

Syllabus

1. Overview of commercial bank financial statements:

Balance sheet, Income statement, off balance sheet items;
the Return on the equity model;
2. Financial ratios and the use of average balance sheet
data;
3. Managing risk and return; and CAMELS composite
rating system.
 Evaluating Bank Performance
Internal Performance
• Bank Planning
• Technology
• Personnel Development.
External Performance
• Market share: It is measured in terms of Assets, deposits, loans and
total financial services held by the bank relative to other BFIs. It is
affected by ROE. Constant rate of return on assets and decline in the
market share results in decrease in EPS.
• Regulatory Compliance: Regulator impose various requirement to
maintain the financial discipline in financial market.
– Eg. Capital Requirements, Liquidity requirements, reserve requirements,
priority sector requirements (25%)
– Non compliance with the regulatory requirements, next possible action is PCA.
Overview of commercial bank financial statements

• QFS_3rd_Qtr_207778_Site.pdf
 Off balance sheet items
• An off balance sheet usually means an assets or debt or
financing activity that is not reflecting on a firm's balance
sheet.
• In other words it is a form of financing in which large capital
expenditures are kept off a firm's balance sheet through
various classification methods.
• Firm's will often use off balance sheet financing to keep
their debt to equity ratios low, specially if the inclusion of a
large expenditure would give them a negative D/E ratio.
• Obligations that are contingent liabilities of a bank, and
thus do not appear on its balance sheet. It includes LC,
Bank guarantee, forward exchange transaction, options,
swaps and other derivatives.
 Analyzing Bank Performance with Financial Ratios

• Profit Ratios : Ratios used to measure the profitability of

a bank
– ROE, ROA, EM, AU, Interest expenses ratios,
Impairment charge ratios, Non Interest expenses
ratios, Tax ratio
• Other ratios
– Net interest margin, spread ratio, overhead efficiency
ratio, non performing assets ratio, operating efficiency
ratio, Volatile liability dependency ratio, GAP ratio etc.
– Analyzing bank performance with Financial ratios..
docx
 CAMELS rating system.
• CAMELS rating system is a rating system used to assess the soundness
of financial institutions. This system was adopted by national Credit
Union Administration NCUA in Oct 1987
• CAMELS stands for, Capital adequacy, Asset quality, Management,
Earning, Liquidity, and Sensitivity to market risk. CAMELS rating system
is to be evaluated on the scale of one to five rating in ascending order
(National Credit Union Administration, 2003).
Capital Adequacy
• Capital is the life blood of every business without which no one can
imagine the business. It is the fund raised to finance different assets
and projects. Sources may be either short term or long term. Capital
fund is shareholder’s total claim on the bank that can be categorized as
core capital and supplementary capital. Core capital is that capital
which is kept in reserve for nonspecific purpose. Supplementary capital
is that capital which is kept in reserve for specific purpose to cover loss.
 CAMELS contd……..
• Indicators of Capital adequacy
Ratios Formula Standards
A. Capital adequacy ratio
- Core capital (CC) Ratio Core capital/Risk
weighted assets 6%
- Supplementary capital (SC) Ratio SC/RWA Not exceed CCR

- Total capital ratio TC/RWA 10%

B. Leverage Ratio CC/TA Better to greater than 4%

Asset quality
• AQ is one of the most important elements of CAMELS frame work to rate a financial institution/bank .
• The bank asset includes among others current asset, credit portfolio, fixed asset, and other investments.
• Loan is the major asset of commercial banks from which they generate income. The quality of loan portfolio
determines the performance of banks.
• To measure asset quality, non-performing loan ratio (NPA) is used.
• Non-Performing loans are defined by NRB as loans overdue for more than 90 days. Lower NPA ratio, better the
asset quality.
 CAMELS contd……..
Indicators of assets quality
Ratios Formula Standards
NPL NPL/Total loans and advance >5%
LLP Total Loan loss provision/Total loans & advance >5%

Management
• Leadership, administration ability, and competency in technical
work
• Bank’s management has the ability to deal with changing situations
• Obedient to banking law and regulations
• Agree on internal policies
• To show keenness in fulfilling the legal need of the community.
• Indicators of management quality are: Operating expenses ratio,
earning per employees etc.
 CAMELS contd……..
Earnings
• To stay in the market for a long term, banks are totally dependent upon
generation of adequate earnings, rewards to be paid back to its
shareholders, protect and improve its capital.
• Indicators of earnings are: ROA, ROE, PM etc.
Liquidity
• A bank with a proper liquidity level will have the possibility to meet its
obligations, even in difficult situations as bank runs. From this
perspective, a “comfortable” ratio decreases the risks of failure which
may reduce the financing costs and enhance the profitability
• On the other hand, liquid assets ( Sum of Cash Balance, Bank Balance, Money
at Call & Short Notice and Investment) bring low returns, which lower the
profitability.
• Indicators of liquidity ratio are: credit to core capital and deposit (80%),
liquid assets to total assets, liquid assets to total deposit (20%), cash
balance with NRB to total deposit (CRR ration 4%)
 CAMELS contd……..

Sensitivity to market risk

• It reflects the degree to which changes in interest rates,
foreign exchange rates, commodity prices, or equity prices
can adversely affect a financial institution's earnings or
capital.
• Determining factors of managing sensitivity to market risks
are: Derivative instruments, fee income business, product
pricing strategies
Numerical Problems