The Evaluation of Bank Performance - Report Example

How would you evaluate the performance of a bank using published accounting data. What other data would you use in this evaluation? 28th Oct; 2009 ABSTRACT: This paper shows few ways as to how you can evaluate the performance of the bank. It holds information as to what key indicator can help you to know about the performance of the bank based on the published data that bank report. Key performance indicators play a crucial role in determining your banks level of performance. Key Performance Indicator may either be financial or non-financial and should be designed in such away to suit the banks working framework, goals and objectives. Key Performance indicators can vary from one bank to another due to different management approaches. INTRODUCTION Banks performance is crucial to any one of us who has deposited cash or is using any service or product of the bank, in order to make the decision in which bank to invest; you must know how the bank is performing in order to do that you can use various financial ratio that can help you in rating the performance of any bank (Brigham & Ehrbardt 194, 2004). Often, a number of criteria such as profits, liquidity, asset quality, attitude towards risk, and management strategies must be considered in evaluating the performance of a bank. A bank’s balance sheet and income statement are the most valuable source of information that can be used in evaluating bank’s performance. The amounts stated on these statements can provide valuable insights into the performance and condition of a bank. The data from these statements can be used to develop financial ratios to evaluate bank performance. Key Ratios to Evaluate Bank Performance Based on Published Data Some of the examples below shows the usefulness of ratios in analyzing bank performance. All the banks publish there financial statements. We can use this information to evaluate the performance of the bank. There are literally hundreds of useful financial ratios you can use to evaluate bank’s performance. However, in most instances, you need a few basic ratios to identify fundamental performance issues (Kunda 2008, 492). Below are some of the key ratios as an example that will show how to evaluate the performance of a bank based on its published data ROE ROA Example of ROE: Bank X has total assets of $50 million, an annual net income of $750 thousand and total equity capital of $3 million (Kunda 2008, 492). Bank Y has total assets of $250 million, net income of $1 million and total equity capital of $15 million.Now the question is if you want to know which bank’s performance is better than the other we can see what the Return on Equity is of both the banks.   Bank X Bank Y Total assets $50 million $250 million Annual net income $750 thousand $1 million Total equity $3 million $15 million Return on your Equity ROE can be one of the key indicator’s to know about the performance of the bank. ROE=Annual Net Income / Total equity Annual Net Income can be extracted from the income statement published by the bank and Total equity can be extracted from the banks balance sheet. Therefore in the above case Bank X ROE=Annual Net Income/ Total Equity=750/3000=25% Bank Y ROE=Annual Net Income/Total Equity=1 / 15= 7% Bank X provides return on equity/investment of 25% and Bank Y provides 7% Top of Form As a customer if given the above information which bank would you invest in term of its financial position , because performance of a bank is also based on its financial position. Bank X   Bank Y Bank X provides a return on equity (shareholder investment) of 25 percent (750/3000). Bank Y provides a return on investment of 7 percent (1/15). The higher the ROE the better the performance. Example of ROA (Return on Asset) Return on Asset (ROA) show how well a company is using its asset in order to be profitable. The ratio helps in knowing how the management is using its assets to generate earnings. It is calculated by dividing a companys annual earnings (which is Net Income) by its total assets, ROA is displayed as a percentage. The formula is ROA=Net Income/Total Asset The ROA shows how well the company is converting the money it has to invest into net income (Wood and Sangster, 2008, 134-258). If the percentages are high, it’s the better, because the company is earning more money on less investment. For example, if one company has total assets of $5 million and net income of $1 million, its ROA is 20%; however, if another company earns the same amount but has total assets of $10 million, it has an ROA of 10%. This example illustrates that, the first company is better at converting its investment into profit. Monitoring the Net Income after Taxes The banks Income statement can play a very crucial role in identifying the banks performance (Wood and Sangster, 2008, 134-258). By monitoring the banks Net Income after Taxes we can get a picture of how the bank is performing. We can take the Income statement for 2 or 4 years and then see the Net Income after Taxes if it’s positive it means the bank has been profitable and performing well if its negative it means the banks has been in a loss and is not performing very well and there might be a risk in choosing that bank to invest. CONCLUSION The cost/income ratio or efficiency ratio is the standard benchmark of banks efficiency. It measures a bank’s operating costs as a proportion of its total profits. Although it’s widely used, the benchmark is an Unreliable and often inaccurate measure of bank efficiency. The cost/income ratio is dependent on factors like lending, borrowing and other activities it undertakes. RECOMMENDATION I would recommend that word of mouth can also play a crucial role in evaluating the performance of the bank, the type of service & product the bank provides. The other thing which is very important is to see how much loan the bank is giving out and what is the deposit input .These two inputs (deposit/loan) play a very important role in banks performance.Usualy banks income is through the long term deposit which customer’s deposit, these deposits are further given off as loan or invested in some projects by the bank in order to get interest income. If the bank is giving out too much of loan an is unable to recover the loan it can effect a banks performance as the provision to Loan loses will increase and can also lead a bank to bankruptcy. The recent recession was basically due to this issue; banks and investment houses had given out large loan to customers and were not able to recover those amounts. Therefore we need to keep above mentioned points in mind. LIMITATION This paper has only taken into account the financial ratios, operational efficiency, services & products provided by the bank can also help in determining the performance of the bank further. Relying too heavily on just a few indicators of banks profitability can be misleading. REFRENCES Brigham, Eugene and Ehrhardt, Michael (2004). Financial Management: Theory and Practice. South-Western: New York Intellectual capital: future competitive advantage for facility management Peter McLennan Facilities; Volume: 18   Issue: 3/4; 2000 Viewpoint Kunda, Z. (2008). The case for motivated reasoning. Psychological Bulletin, 108, 480–498. Pinsent, Wayne “Credit Default Swaps: An Introduction” .2009. Investopedia.com http://www.investopedia.com/articles/optioninvestor/08/cds.asp  St Labs, Stanley. "The US Economy: USA Economy, American Economic Profile, Economy of the United States of America." Economy Watch. 2007. Web. 3 Nov. 2009. . Shinkle, Kirk. “The Ticker.” 2009. US. News. Read More