1. 6-1
TABLE 6–1 Components of Return on Equity (ROE) for All FDIC-Insured Institutions ( )
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2. Evaluating Performance (continued)
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Evaluating Performance (continued)
A slight variation of the simple ROE model produces an efficiency equation useful for diagnosing problems in four different areas in the management of financial-service firms or
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3. Evaluating Performance (continued)
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Evaluating Performance (continued)
We can also divide a financial firm’s return on assets into its component parts
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4. TABLE 6–2 Calculating Return on Assets (ROA)
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TABLE 6–2 Calculating Return on Assets (ROA)
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5. 6-5
TABLE 6–3 Components of Return on Assets (ROA) for All FDIC-Insured Depository Institutions (1992–2009)
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6. Evaluating Performance (continued)
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Evaluating Performance (continued)
Achieving superior profitability for a financial institution depends upon several crucial factors
Careful use of financial leverage (or the proportion of assets financed by debt as opposed to equity capital)
Careful use of operating leverage from fixed assets (or the proportion of fixed-cost inputs used to boost operating earnings as output grows)
Careful control of operating expenses so that more dollars of sales revenue become net income
Careful management of the asset portfolio to meet liquidity needs while seeking the highest returns from any assets acquired
Careful control of exposure to risk so that losses don’t overwhelm income and equity capital
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7. Evaluating Performance (continued)
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Evaluating Performance (continued)
Risk to the manager of a financial institution or to a regulator supervising financial institutions means the perceived uncertainty associated with a particular event
Among the more popular measures of overall risk for a financial firm are the following
Standard deviation (σ) or variance (σ2) of stock prices
Standard deviation or variance of net income
Standard deviation or variance of return on equity (ROE) and return on assets (ROA)
The higher the standard deviation or variance of the above measures, the greater the overall risk
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8. Evaluating Performance (continued)
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Evaluating Performance (continued)
Bank Risks
Credit Risk
Liquidity Risk
Market Risk
Interest Rate Risk
Operational Risk
Legal and Compliance Risk
Reputation Risk
Strategic Risk
Capital Risk
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9. Evaluating Performance (continued)
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Evaluating Performance (continued)
Other Goals in Banking and Financial-Services Management
A rise in the value of the operating efficiency ratio often indicates an expense control problem or a falloff in revenues, perhaps due to declining market demand
In contrast, a rise in the employee productivity ratio suggests management and staff are generating more operating revenue and/or reducing operating expenses per employee, helping to squeeze out more product with a given employee base
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10. Performance Indicators among Banking’s Key Competitors
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Performance Indicators among Banking’s Key Competitors
Among the key bank performance indicators that often are equally applicable to privately owned, profit-making nonbank financial firms are
Prices on common and preferred stock Return on equity capital (ROE)
Return on assets (ROA) Net operating margin
Net interest margin Equity multiplier
Asset utilization ratio Cash accounts to total assets
Nonperforming assets to equity capital Interest-sensitive assets to interest-
ratio sensitive liabilities
Book-value assets to market-value assets Equity capital to risk-exposed assets
Interest-rate spread between yields on Earnings per share of stock
the financial firm’s debt and market
yields on government securities
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11. The Impact of Size on Performance
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The Impact of Size on Performance
When the performance of one financial firm is compared to that of another, size becomes a critical factor
Size is often measured by total assets or, in the case of a depository institution, total deposits
Most performance ratios are highly sensitive to the size group in which a financial institution finds itself
The best performance comparison is to choose institutions of similar size serving the same market area
Also, compare financial institutions subject to similar regulations and regulatory agencies
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12. 6-12
TABLE 6–4 Important Performance Indicators Related to the Size and Location of FDIC-Insured Depository Institutions (2009)
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13. 5-13
Quick Quiz
What individuals or groups are likely to be interested in the banks’ level of profitability and exposure to risk?
What are the principal components of ROE, and what does each of the these components measure?
What are the most important components of ROA and what aspects of a financial institution’s performance do they reflect?
Why do the managers of financial firms often pay close attention today to the net interest margin and noninterest margin? To the earnings spread?
To what different kinds of risk are banks and their financial-service competitors subjected today?
What items on a bank’s balance sheet and income statement can be used to measure its risk exposure? To what other financial institutions do these risk measures seem to apply?
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14. 5-14
Appendix: Using Financial Ratios and Other Analytical Tools to Track Financial-Firm Performance – The UBPR and BHCPR
Compared to other financial institutions, more information is available about banks than any other type of financial firm
Through the cooperative effort of four federal banking agencies – the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, and the Office of the Comptroller of the Currency – the Uniform Bank Performance Report (UBPR) and the Bank Holding Company Performance Report (BHCPR) provide key information for financial analysts
The UBPR, which is sent quarterly to all federally supervised banks, reports each bank’s assets, liabilities, capital, revenues, and expenses, and the BHCPR is similar for BHCs
Web link for UBPR and BHCPR:
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