Bank-Specific Ratios
Exclusive financial standards used by the banking sector to determine the profitability and strength of banks.
What are Bank-Specific Ratios?
Bank Specific Ratios are exclusive financial standards used by the banking sector to determine the profitability and strength of banks. Therefore, talking specific ratios are considered when discussing bank prosperity and advancement.
Each value indicates whether the bank is doing well or needs to work harder toward achieving success. Hence, like other businesses, banks use certain ratios to gauge profitability and efficiency tailored to their individual company processes.
Bank research has always been difficult since banks operate and profit differently than most other firms. For example, while other companies develop or manufacture goods for sale, a bank's principal product is money.
Investors and financial analysts use a variety of ratios to evaluate a bank or financial institution, including return on assets, loan to assets, capital adequacy, and many other ratios.
Choosing essential financial ratios among a large number of options is difficult. Still, the analytical skill is in finding the basic financial features of the bank represented in ratios, not in computing the exact ratio.
Certain figures should be displayed clearly in front of you as investors or customers who want to do business with any financial institution or bank. These figures are related to bank-specific ratios that will lead you to the appropriate decision.
In addition, these ratios are involved in the banking industry benchmark analysis. That represents a focal point of interest for the bank, the stakeholders, and regulatory agencies.
The bank can analyze its performance, compare it to competitors, and apply modifications if needed.
While stakeholders can measure if the bank is a rock-hard investment, the regulatory system is empowered to see whether the bank complies with the regulation of liquidity and solvency.
While liquidity and solvency ratios are critical components of financial analysis, banks can compare their efficiency, performance, and profitability using a variety of ratios ranging from customer service to employee levels.
Banking sector benchmark ratios are even more crucial nowadays to assess, as banks continue to face challenges from growing market competitiveness, more regulatory expenses, and rising cybersecurity jeopardies.
Key Takeaways
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Bank-specific ratios play a pivotal role in the financial landscape, providing vital insights into the health and performance of banks.
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These ratios serve a diverse audience, including investors, regulatory bodies, and the banks themselves, and are crucial for understanding a bank's financial standing, especially during different economic and credit cycles.
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They encompass a wide range of financial metrics that evaluate various facets of bank operations, such as efficiency, liquidity, asset management, debt management, and profitability.
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Efficiency ratios, for instance, gauge how well a bank controls its operational costs, indicating its ability to manage expenditures relative to revenue. Liquidity ratios assess a bank's ability to meet short-term obligations, with indicators like the current ratio, credit to deposit ratio, CASA ratio, and interest expended to total funds.
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By providing a comprehensive view of a bank's financial performance, these ratios enable stakeholders to make well-informed decisions, help banks plan for the future, and ensure regulatory compliance in terms of liquidity and solvency.
Why are Bank Specific Ratios significant?
The ratios specific to banks help the investors and regulatory institutions understand the bank's financial position and how it will fare during various parts of the broader economic and credit cycles. The process relies on evaluating the numerical data of each ratio between the historical values and the current numbers.
Ratio analysis will help to understand the comparison of these numeric data and predict the approximate profit or loss.
These ratios will also aid in comprehending the ability to generate money from assets or equity and the sales and revenue spheres.
It is useful in planning and foreseeing future operations that should be addressed to help budget and plan future expansion.
Hence, it is a good method for investigating risks and assists in making appropriate management decisions to protect business investments.
Also, these ratios help in SWOT (Strengths, Weaknesses, Opportunities, and Threats) analysis that tells whether the company can perform growth. And to compare this growth to other competitors' performance.
Thus, the specific ratios analysis will give us a trend line that will exhibit whether the bank can operate correctly over time.
These bank-specific ratios tackle diverse facets of business, such as liquidity, efficiency, solvency, leverage, profitability, and market value. In addition, it elucidates reliable resources for management, investors, and customers to make factual decisions.
What are the types of Ratios?
Accounting ratios provide a straightforward framework for measuring the bank's financial position.
Bank-specific ratios provide a tool for assessing the overall health of a bank. Thus, multiple ratios exist; efficiency, liquidity, assets, debt, and profitability are the most frequently utilized to assess the whole picture.
Even though it might not be feasible to continuously evaluate all of these at once, it's important to choose a few that are important to your organization's operations so you can keep informed about what's occurring there.
Efficiency
One important performance indicator used to evaluate the bank's economic growth is the efficiency ratio. It is also known as a bank's "Cost to Income Ratio" and is computed by dividing operational expenditures by total income.
This indicator is crucial because it shows how well a bank controls its cost base, indicating how many operational expenditures are incurred for every dollar of revenue. As a result, banks strive to maintain this measure as low as possible and frequently reveal a target rate in their accounting records – normally, this objective is 50-60%.
A bank's running expenditures are comprised of employee and installation costs. These expenses are often steady over time, although a bank's income varies yearly based on economic conditions. This may make the statistics unpredictable, especially if a bank's income fluctuates dramatically yearly.
Efficiency Ratio = (Non-Interest Expense) / Revenue
Liquidity
A vital range of financial measures termed liquidity ratios is used to assess a debtor's capacity to settle existing debt payments without outside funding. Ratios, including the current ratio, quick ratio, and operating cash flow, are calculated to complete this procedure.
1. Current
The current ratio measures the ability to pay off current liabilities with total current assets like cash and inventories. Therefore, the higher the ratio, the better the bank's position.
Current = Current Assets / Current Liabilities
2. Credit to Deposit
This compares the bank's total credit to the sum of its bank deposits. This aids in evaluating the liquidity status of the bank.
This shouldn't be either too high or too low; thus, the percentage that must be maintained must strike a balance.
A ratio of more than 100 indicates that the bank has made more loans than it has taken in as deposits.
LDR= (Total Loans)/ (Total Deposits)
3. CASA Ratio
The current account and savings account is referred to as CASA.
The CASA ratio computes the percentage of total deposits deposited in current and savings accounts.
The cost of capital for the bank is lower the greater the ratio, which considerably aids banks in cutting operational costs.
CASA Ratio = (CASA Deposits) / (Total Deposits)
4. Interest Expended to Total Funds:
The money charged on the deposits that the bank has accepted the interest expenditure. It provides data on the cost of resources for deposits.
A non-operating item that appears on the income statement is interest expense. It stands for the interest owed on all borrowings, including securities, loans, and credit lines.
Interest Expended to Total Funds= (Interest Expense) / (Total Deposits) ×100
Asset Management
Asset Management Ratios demonstrate how well a corporation manages its assets to produce and optimize sales revenues. In addition, the goal is to assess how well the business can efficiently use its resources to generate money.
1. NPA
Loans or mortgages in default are classified as nonperforming assets (NPAs). When the lender believes the loan terms have been violated and the borrower cannot fulfill his payments, the loan is in default. It is considered secure if the percentage is below 10%.
(Amount Under NPA Loan Accounts) / (Total Loan Outstanding) ×100
2. Coverage
The coverage ratio denotes a company's ability to pay off outsiders' debts. A ratio greater than one usually indicates a good position to pay off the liability or obligation.
The coverage ratio is an essential financial measure from the perspective of long-term creditors and lenders. It is because the ratio speaks about the firm's ability to pay off creditors' and lenders' commitments.
Coverage = (Total Tangible Assets – Short Term Liabilities) / Total Outstanding Debt
Debt Management
Debt Management Ratios aim to gauge a company's use of financial leverage and its long-term ability to avoid economic hardship.
Long-Term Solvency Ratios are another name for this category. Because they can increase stockholder returns in prosperous years and decrease them in dormant years, debt is also known as financial leverage.
Here are some examples of debt management ratios:
1. Debt-to-assets
Reveals the amount of the asset base that is financed by debt. All current liabilities and long-term debts together make up total debt.
Creditors prefer low debt ratios because they provide a larger safety net against loss in liquidation. The main thing to remember is that a company is insolvent if its assets are financed by debt.
Debt-to-Assets = (Total Debt) / (Total Assets)
2. Debt-to-Equity
This ratio is commonly used to determine how much debt a company has for every dollar of equity.
Debt-to-Equity = (Total Debt) / (Total Common Equity)
3. The Capital Adequacy
The capital adequacy ratio (CAR) compares a bank's capital to its risk-weighted assets and current liabilities. As a result, central banks and bank regulators decide to protect commercial banks from taking on excessive debt and falling insolvent in the process.
There are two categories of capital measured: tier-1 capital, which can absorb losses without requiring a bank to discontinue operations, and tier-2 capital, which can absorb losses in the case of switchbacks but offers less coverage to depositors.
The ratio is calculated using tier-1 capital, and tier-2 capital divided by Risk-Weighted Assets.
Tier-1 capital, also known as core capital, comprises equity capital, common stock, intangible assets, and audited revenue reserves. Unaudited retained profits, unaudited reserves, and general loss reserves make up Tier-2 capital.
Risk-weighted assets are used to establish the minimum cash reserve that banks and other financial institutions should hold to mitigate the risk of insolvency.
CAR = (Tier 1 Capital+ Tier 2 Capital) / (Risk Weighted Assets)
Profitability
A category of financial measurement known as profitability is used to evaluate a company's capacity to create profits in accordance with its earnings.
Profitability ratios show how well a business makes money and adds value for shareholders; results with a higher ratio are frequently preferable.
1. Net profit margin
In the banking industry, a bank's net interest margin is calculated as total interest income less total interest expenditure.
Banks generally make interest revenue by loans to companies, real estate developers, and individuals. Interest expenditure is the interest the bank must pay on different interest-bearing deposit accounts that people and companies hold with the bank.
Net profit margin = (Net Income) / Revenue × 100
2. Return on Assets
The return on assets (ROA) is a tool for gauging how much money a company makes from its capital. This profitability ratio illustrates the increase in profits produced by an organization's assets.
Return on assets shows investors how well a firm creates profit growth from money supplied to it, including debt and stock. This indicator is used to compare similar firms or to assess how a company has performed over time.
ROA = (Net Income) / (Total Assets)
The return on equity ratio, often known as the ROE, is a profitability statistic that assesses a company's capacity to make a profit from the investments made by its shareholders.
In other words, the return on equity ratio displays the profit produced for each dollar of equity held by common stockholders.
ROE = Net Income / (Shareholder's Equity)
Summary
To conclude, bank-specific ratios represent a very useful measurement strategy that allows the bank to forecast new developmental and disciplinary strategies, leading the bank to more prosperity and profitability.
As we saw, specific ratios are constantly used in banks' financial analysis over time. True, the financial analysis includes diversified measurements that tackle the different sectors and aspects of the bank's business.
Hence, the aforementioned types above are the most vital ratios that banks need to focus on. And by examining their liquidity, earnings, asset management, and efficiency ratios.
These ratio analyses are commonly utilized for making key judgments and anticipating the future. Studying the values and comparing them with the values of peers or even the bank itself from a previous time will allow the bank to evaluate initial strengths and weaknesses.
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