Question

Detail and give examples of two (2) financial ratios often used to provide a direct measure of a commercial bank’s credit risk exposure.

Include:

Definition of each ratio including formula and conceptual meaning.
Specific examples to illustrate what is measured by each ratio.

Answer 1

1. Capital adequacy ratio= (Tier 1 Capital+ Tier 2 Capital)/risk weighted assets

= Capital adequacy ratio is the most prominent ratio which is used in relation to the credit worthiness of the bank and it will be helpful in determination of the risk weighted positions of the bank in a relationship with their total capital so the total capital of the bank will be reflection of the overall risk it can undertake during the financial downturn,so it will provide a high degree of creditworthiness reflection due to risk weighting of the Assets and it will reflect that it the bank can survive or sustain in the long run or not.

For example, it will be trying to determine the risk in relation to the total capital of the bank

2. Deposit to loan ratio= (total deposit/total loans)= total deposits to loan ratio will be a direct measure of total deposit in relationship with the total loan which are provided by the bank and it will directly provide a reflection of the short term as well as long term matching risk of business because the short term loans will be able to cover with the short term deposits and the long term loans should be able to cover with the long term deposits so there will be no duration mismatch and the company can survive and sustain in the long run.

for example it will be able to determine the Asset liability mismatch to a large extent.