What
are the important determinants of the financial performance of banks?
When you are
investing in stock, you should perform a careful analysis of financial data to
explore the bank's true worth. You can do this by examining and evaluating the bank's
financial statements. This is time-consuming and cumbersome and you are
expected to have sound knowledge of the measurement bases used in the financial
statements.
To overcome this
problem, you can use different financial ratios that depict the performance and
health of the bank. Ratios are not all in all but they may give indications
about the performance and health of the company with no loss of time.
Among them some of
the most important indicators to look out for in order to determine the
financial performance of banks are as follows:
1.
Return on Assets (ROA)
2.
Management Efficiency (ME)
3.
Liquidity (LIQ)
4.
Credit Risk (CR)
5.
Asset Quality (AQ)
6.
Operational
Efficiency (OE)
1.
Return on
Assets (ROA)
It
compares relative profit in relation to the total assets of the bank. The net
income of the bank when divided by total assets gives the figure of ROA.
What
indication is given by ROA?
-It
indicates the financial performance of the bank as compared to other banks.
-It
also indicates how efficiently the bank is using its resources to generate
income.
2. Management Efficiency (ME)
This ratio depicts how efficiently the
management team has created output relative to capital assets. The net income
of a bank when divided by total revenue gives the figure of ME.
What indication is
given by ME?
It indicates
-The financial performance of
the banks.
The
following parameters are also observed in relation to ME
-Management System
-Organizational Discipline
-Cost Control System
-Quality of Staff
-Asset, earnings, and profit growth
3. Liquidity (LIQ)
This ratio shows the relationship
between the total loan and the total deposit of the banks. The total loans
divided by the total deposits give the figure of LIQ.
What
indication is given by LIQ?
-It indicates
the liquidity of the banks.
4. Credit Risk (CR)
This shows the relationship
between the total loan loss provision created and the bank's total loan. The total
loan loss provision when divided by the total loan gives the figure of CR.
What
indication is given by CR?
-It indicates whether the bank has sufficient
provision to withstand credit default resulting from the non-performing loan.
5.
Asset
Quality (AQ)
This measures the non-performing
loan of the banks in comparison to the total loan of the banks. The non-performing
loan when divided by the total loan gives the figure of AQ.
What
indication is given by the DP ratio?
-It indicates the quality of earning
assets of the banks.
6.
Operational Efficiency
(OE):
This measures
the relationship between total interest income and the total operating expenses of
the banks. The total interest income when divided by total operating expense
gives the figure of OE.
What indication is given by OE?
It indicates the operational
efficiency of the banks.
Be
Aware:
Financial ratios are not all in
all. They are only indicators. They give relative values. Indicators can help
you assess the value of a stock and its growth potential. But there are many
other factors that affect stock prices that can't be easily predicted or
measured.
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