Methods of Bank Performance Evaluation

methods of bank performance evaluation

A bank is evaluated based on profit and loss in the same way for other businesses. If the shareholder of the bank gets more profit, then the bank is identified as successful. Banks can attain success if relevant risks are effectively controlled.

The 5 types of risks that are needed to be carefully controlled.

    1. Credit Risk.
    2. Liquidity Risk.
    3. Interest Rate Risk.
    4. Capital Risk.
    5. Operating Risk.

The tools for measuring the major risks of a Bank are given below:

  1. Credit Risk.
    1. The ratio of net loan loss to total loans.
    2. The ratio of loan loss reserve to the total loss.
    3. The ratio of loan provision to total loan.
    4. The ratio of default loan to total loan.
    5. Rate of annual increase of loan.
  2. Liquidity Risk.
    1. The ratio of total equity capital to the total asset.
    2. The ratio of core deposit to the total asset.
    3. The ratio of purchased liability to the total asset.
    4. The ratio of securities of less than one year to the total asset.
    5. The ratio of the market price of securities to the face value of securities.
  3. Interest Rate Risk.
    1. The ratio of liability-based assets to earning assets.
    2. The ratio of three-month maturity securities to one-year maturity securities.
  4. Capital Risk.
    1. The ratio of the total risk of equity holders to the total asset.
    2. The ratio of primary capital to the total asset.
    3. The ratio of cash dividend to total earnings.
  5. Operating Risk.
    1. Per employee total assets.
    2. Per employee salary and allowances.
    3. Proportion interest expenses to house rent & furniture.

Indicators of a Successful Bank

Successful banks must be identified Tor the interest of the depositors and the country as a whole. The bank, which has a better financial condition, is less risky and relatively more profitable, is identified as a successful bank determined by ratio analysis based on past data. This analysis may be vertical or horizontal.

This determination of a successful bank is not restricted based on financial information only because many other quantitative analyses are also used.

However, indicators of a successful bank based on ratios are given below:

Higher Ratios indicating Successful BankLower Ratios indicating Successful Bank
1. Ratio of interest income to total assets.1. Ratio of loans and advances to total assets.
2. Ratio of securities to total assets.2. Ratio of interest expense to total assets.
3. Ratio of earning assets to total assets.3. Ratio of interest expense to interest-bearing liabilities.
4. Ratio of current deposits to total liabilities.4. Ratio of non-interest expense to the total asset.
5. Ratio of bank capital to total assets.5. Ratio of provision for loan loss to the total asset.
6. Per employee assets.6. Ratio of loan loss to total loans and advances.
7. Salaries and allowances per employee.7. Ratio of non-performing loans and advances to total loans and advances.

Performance-Based Classification of Bank

Based on the degree of performance, banks are often classified into:

  • Best performer bank as “A” Category bank.
  • Moderate performer as “B” Category Bank.
  • Average performer as “C” Category Bank.
  • Below average performer or sick bank as “D” Category Bank, and
  • Losing and bad performer as “E” Category Bank.

In the United States of America, most of the regulating agencies of banks follow similar methods in evaluating banks’ performance. This approach is known in the USA as the Uniform Inter-agency Bank Rating System.

The widely known & most popular method involved in the USA and the other Western countries and elsewhere is the CAMELS rating system.