Question

List explain and show how to calculate two specific ratio measures that could be used to measure a banks credit risk. In each case explain whether an analyst would want a higher or low ratio than the ratios of the banks peer group and why

Answer 1

The credit analysis ratios helps analyst to determine the capability of the banks to fulfil their financial obligations. Two ratios that could be used to determine the credit risk associated with banks are:

1. Credit to deposit ratio: The ratio is calculated by dividing the total creations of loan assets of the banks by total deposits of the banks. It estimates the amount of credit advanced by the banks from the deposits they received. The higher credit to deposit ratio means that the banks has created more loan assets from the deposits. The analyst would want a low credit to deposit ratio as with high credit to deposit ratio banks will become reluctant to lower the interest rates.

2. Return on assets ratio: The ratio is calculated by dividing the net profits by average total assets of the banks. It indicates the ability of the banks to generate profits from their total assets. The return on the assets will tend to increase with the increase in return to assets ratio. The analyst will thus want a higher return to asset ratio in order to receive higher return of the assets.