Banking Financial Ratios
Among the main financial ratios, investors and market analysts are dedicated to evaluating the net interest margin, loan-to-asset ratio, and return on assets (ROA) ratios of retail banking companies. The analysis of banks and banking stocks has been particularly challenging because banks operate and generate profits in a completely different way from most other businesses. When other industries create or manufacture products for sale, the main product the bank sells is currency.
The financial statements of a bank are generally much more complex than those of companies engaged in almost any other type of business. When investors considering bank stocks consider traditional equity evaluation indicators such as price-to-book ratio (P/B) or price-to-earnings ratio (P/E), they also check industry-specific indicators to more accurately assess the potential of investing in individual banks .
- The analysis of banks and banking stocks is particularly challenging because they operate and make profits differently from most other businesses.
- The net interest margin is an important indicator for evaluating banks because it reveals the bank’s net profit on interest-bearing assets (such as loans or investment securities).
- Banks with higher loan-to-asset ratios get more income from loans and investments.
- Banks with lower loan-to-asset ratios account for a relatively large portion of their total income from more diversified non-interest-bearing sources, such as asset management or trading.
- Return on assets is an important profitability ratio that represents the profit per dollar a company receives from its assets.
The retail banking industry includes banks that provide direct services (such as checking accounts, savings accounts, and investment accounts) and loan services to individual consumers. However, most retail banks are actually commercial banks that provide services to corporate customers and individual customers. Retail banks and commercial banks usually operate separately from investment banks, although the repeal of the Glass-Steagall Act legally allows banks to provide both commercial and investment banking services.The retail banking industry, like the entire banking industry, derives income from its loans and services.
In the United States, the retail banking industry is divided into major currency center banks, the four largest being Wells Fargo, JPMorgan Chase, Citigroup, and Bank of America, followed by regional banks and savings banks.When analyzing retail banks, investors will consider providing profitability indicators that are considered the most suitable for performance evaluation in the banking industry.
Net interest margin
The net interest margin is a particularly important indicator for evaluating banks because it reveals the bank’s net profit on interest-bearing assets (such as loans or investment securities). Since the interest earned by such assets is the bank’s main source of income, this indicator is a good indicator of the bank’s overall profitability. A higher profit margin usually indicates a higher profitability of the bank. Many factors can significantly affect the net interest margin, including the interest rate charged by the bank and the source of bank assets. The net interest margin is the sum of interest and investment income minus related expenses; then this amount is divided by the average total amount of assets earned.
The loan-to-asset ratio is another industry-specific indicator that can help investors obtain a complete analysis of bank operations. Banks with a relatively high loan-to-asset ratio derive more income from loans and investments, while banks with a lower loan-to-asset ratio derive a relatively larger portion of their income from more diversified non-interest income, such as assets Management or transaction. When interest rates are low or credit is tight, banks with lower loan-to-asset ratios may perform better. During the economic downturn, their performance may also be better.
Return on assets
Return on assets (ROA) ratios are often applied to banks because cash flow analysis is more difficult to construct accurately. This ratio is considered to be an important profit ratio, indicating the profit per dollar a company receives from its assets. Since bank assets mainly consist of bank loans, the rate of return per dollar is an important indicator of bank management. The ROA ratio is the company’s net income after tax divided by its total assets. An important point to note is that due to the banks’ high leverage ratio, even a relatively low ROA of 1% to 2% may represent the bank’s considerable income and profits.