Question

What are the main ratios used to evaluate Banks performance ?
Please give me an explanation of how each ratio measure the performance of banks

Answer 1

Banking is very much regulated industry and it is very important to make proper evaluation of banks because it always deals with lot of liquid funds and the cashflow is always very much high in the banking industry. So there are many methods are used by the analyst for making proper analysis. Ratio analysis is an important one among them. It includes different ratios which are calculated by comparing different financial data. Some of the key financial ratios investors use to analyze banks include efficiency ratio, operating leverage and the net interest margin etc. By using these ratios analyst or investors can identify the performance of the bank. The key ratios to analyse banks performance are explained below.

1.Efficiency ratio - This ratio efficiency of a bank’s operation by dividing non-interest expenses by revenue. This ratio is used to know how the bank uuse its revenue to meet its expenses. The higher efficiency ratio shows the less efficiency because ratio will be high when the expense is high.

Efficiency Ratio = Non-Interest Expense / Revenue

2. Operating leverage - This is also a efficiency ratio. Here the growth interest expenses is deducted from growth of revenue.  It compares the growth of revenue with the growth of non-interest expenses. This will also helps to identify the efficiency of bank

Operating Leverage = Growth Rate of Revenue – Growth Rate of Non-Interest Expense

3. Net interest margin - Net interest margin measures the difference between interest income and interest expenses. A bank’s income and expenses is created by interest. Since the bank funds a majority of their operations through customer deposits, they pay out a large total amount in interest expense. Interest on loans can be considered as the major revenue for the banks and interest paying by banks for the deposit made by the customers is the expenses for the bank

Net Interest Margin = (Interest Income – Interest Expense) / Total Assets

4.  Liquidity Coverage Ratio - This ratio define the liquidity of the bank according to the cashflow. Bank should maintain liquidity because the need cash all the time for pay back to its customers. So this ratio tells that the liquidity position of the bank.

Liquidity Coverage Ratio = High-Quality Liquid Asset Amount / Total Net Cash Flow Amount

These are the key ratios used to evaluate the banks performance.

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