Question

Discuss in detail 3 financial ways of evaluating performance of banks and mention two weaknesses of each method discussed.

Answer 1

The depositors, shareholders, financial market, regulators, credit rating companies etc are interested to know about the financial performance of the banks. Performance of the banks is important in deciding technological innovations, achieving of objectives and to identify the need of change to improve the performance. Financial analysis measures the liquidity, profitability assets quality and credit performance. Most commonly used techniques of financial analysis are financial ratios. It analyses the past and present trends and helps to forecast future trends.

3 financial ways of evaluating performance of banks are:

1. Profitability analysis : Profitability can be measured by Return on Assets (Net income/Total assets), Return on Deposits (Net profit/Deposits), Return on Equity (Net income/Equity) and Net Profit Margin. ROA measures banks ability to use assets to generate income. ROD measures the ability to use deposits to generate income. ROE measures income generation from shareholder's fund. MPM measures net profits out of total revenue. Thus all these three ratios measures profitability.
2. Liquidity analysis : To Analyses the liquidity, various ratios are available. Among those Total Loans to Total Deposits Ratio and Total Deposits to Total Assets ratio are important. Higher Loans to Deposits Ratio indicates financial stress and low Loans to Deposits Ratio is considered to be favorable. Total Deposits to Total Assets ratio indicates broad reliable base of funding that is how much of assets are funded by deposits.
3. Assets Quality or Credit Performance : Almost all the banks will have some bad loans and losses. So these losses must be minimised to increase the profits. It can be analysed by using the ratio of Provisions to Total assets Ratio ie; Provisions to Loans Ratio.

Limitations these ratios

• The above mentioned profitability ratios can be increased or decreased by manipulating the profits
• There is a possibility of being bluffed
• Liquidity ratios should not be mechanically interpreted because the market values of assets are not considered in the ratio calculation
• Inflation is an another factor which question the reliability of these ratios
• Asset quality ratio indicates the quality of assets of the bank blindly. It is not possible to interpret correctly the ratio's results.'Because the value of assets and provisions can be manipulated
• All these ratios are based on financial statements. The changes in the accounting policies of each bank may lead to difficulty in comparison.