Financial Ratios of Major Commercial Banks SSRN

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Financial Ratios of Major Commercial Banks

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DOI: 10.2139/ssrn.1015238
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Sree Rama Murthy Y
Sultan Qaboos University
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A STUDY ON
FINANCIAL RATIOS OF
MAJOR COMMERCIAL BANKS
Dr. Y. Sree Rama Murthy
Director Research & Senior Faculty Member
College of Banking & Financial Studies
Sultanate of Oman
RESEARCH STUDIES 2003
_______________________________________________________
College of Banking & Financial Studies

PO Box 3122, PC 112
Sultanate of Oman
CONTENTS
Chapter 1
INTRODUCTION
Chapter 2
PROFITABILITY
MANAGEMENT RATIOS
Chapter 3
LIQUIDITY RISK MANAGEMENT
Chapter 4
INTEREST RATE RISK MANAGEMENT
Chapter 5
CAPITAL ACCOUNT
MANAGEMENT
Chapter 6
CREDIT RISK MANAGEMENT
Chapter 7
COST MANAGEMENT
Chapter 8
INTERNATIONAL COMPARISONS
Chapter 9
CONCLUSIONS
REFERENCES
Summary
The objective of the study is to calculate the important financial ratios of major
commercial banks in Oman and compare their financial management practices as
indicated by the ratios. The study also compares ratios of commercial banks in
Oman with ratios of other banks in developed countries so that it throws up not
only intra country performance comparisons but also cross country comparisons
which makes study all the more useful.
For the purpose of the study data was drawn from the balance sheets and income
statements of commercial banks. The study uses data from December 1997 to
December 2004 for the profitability ratios part of the study. For studying liquidity,
interest rate risk, capital adequacy etc the study uses the data from December 2000
to 2004. For purposes of international comparisons data was drawn from various
internet based sources and from the Banker Journal.
The ratios used in the study are divided into five broad groups:
Liquidity Management Ratios
Interest Rate Risk Management Ratios
Credit Risk Management Ratios
Capital Account Management Ratios
Cost Management Ratios
Profitability Management Ratios
Each group of ratios throws light on the differences in financial management
practices of banks in the respective area. The study clearly shows that there are
wide differences in the ratios of different banks and that some banks have better
financial management practices than others. A reading of the study allows us to
identify best practice in each of the areas of liquidity management, interest rate risk
management, credit risk management, capital account management and cost
management.
Chapter 1
INTRODUCTION
INTRODUCTION
This study aims to compare different banks in the Sultanate of Oman using a variety
of ratios which are indicators of financial management. The study also compares the
financial performance of
banks with those in other countries (although such
comparisons may not be strictly valid due to differences in money & capital market
conditions, regulatory environment and size differences).
Published financial statement (balance sheet and profit & loss account) data of six
major local commercial banks in Oman are used in the study. It was felt that noncommercial and specialized banks cannot be assessed using the same ratios as the
ones used in this study and were therefore not included in the study.
The banks included in the study are:

Bank Muscat
National Bank of Oman
Oman International Bank
Oman Arab Bank
Bank Dhofar Al Omani Al Fransi
Majan International Bank
However the names of the banks are not mentioned while analyzing the data as the
purpose of the study is to provide information which would throw light on the
performance of the banks in general and is not to comment on any bank in particular.
Best ratios and best practice would also enable other banks to check whether they can
improve their performance in that area of management.
For the purpose of analysis the banks are mentioned as Bank A, Bank B, Bank C,
Bank D, Bank E and Bank F but are not in the same order as the list given above.
The second part of
the study compares the performance of
commercial banks in
Oman with commercial banks in other countries. However a smaller set of ratios is
used in this section on international comparisons, because of data constraints and
availability of data.
The ratios used in the study are :
Loan to Deposit Ratio(%)

Liquid Asset Ratio(%)
Asset Interest Yield(%)
Break Even Yield(%)
Net Interest Margin(%)
Return on Assets (ROA)%
Leverage Multiplier (Lf)
Return on Equity (ROE)%
(Profits on Average Capital)
Capital Adeqacy Ratio (BIS) %
Loan Loss Provision as % of
Total Loans
Risk Adjusted Margin (RAM) %
Overhead Burden Ratio
Productivity Ratio
Cost/Income Ratio
Asset Yield %
Profit Margin%
Cumulative Gap (0 -12months)
(RSA - RSL) (in millions)
Cum Gap/Assets( %)
Capital Assets Ratio %
NPL to Total Loans %
The above ratios are divided into the following five groups :
Liquidity risk management ratios

Interest rate risk management ratios
Capital account management ratios
Credit risk management ratios
Cost management ratios
The above five are the critical management variables in bank financial management
[Sinkey (1989)1 and Prefontaine & Thiebault (1993)]2. Any bank which successfully
manages these five critical variables will be able to achieve success in profitability
management which is
what bank financial management is all about.
While
comparing different banks on the above facets, it is important to also recognize that
there are trade offs between the variables. For example a bank may be successful in
liquidity management by maintaining a high level of liquidity but in the process will
be able to lend less and may in the process make less of profits. Comparing the
profitability management of banks can to some extent reveal how the trade offs were
managed.
After discussing profitability trends using the Dupont model, the performance of
different banks in the above five critical management areas is analysed.
Sinkey, J. F., Commercial Bank Financial Management, New York: Macmillan, 1989
Prefontaine, J & Thibeault A, Introduction to Bank Financial Management, Institute of Canadian

Bankers, 1993
Chapter 2
PROFITABILITY
MANAGEMENT
PROFITABILITY
MANAGEMENT RATIOS
Profitability can be measured by a variety of ratios depending on the purpose of the

study. For purpose of profit comparisons a popular ratio is Return on Equity,
which is essentially Profit after Tax divided by Shareholders equity.
From the
investors point of view Return on Equity on a Post Tax basis is a better measure of
profitability. While ROE (post tax ) itself is not an indicator of investors return on
investment (investors return on investment would rather depend on dividend declared
plus capital appreciation if any ) we can argue that a higher ROE leads to better
return to the shareholders.
Return on Assets is another good measure of performance and profitability. However

ROA does not reflect the impact of capital structure decisions ( financial leverage
also called gearing ) on the firms earnings.
For the purpose of studying profitability the study uses the Dupont Model.
Return on Equity = Profit Margin Asset Yield Leverage
Return on Equity = Return on Assets Financial Leverage
The Dupont model expresses profitability as a percentage of total assets and total
shareholders equity. This is last property is very useful to evaluate how a bank is
doing over time.
The Dupont model decomposes ROE into its two related components : ROA and Lf
where ROA measures operational profitability whereas Lf measures financial risk
which in turn is the result of capital structure decisions. ROA is further broken
down into its determinants : Profit Margin and Asset Yield. Asset Yield measures
asset productivity and Profit Margin measures cost productivity.
DUPONT MODEL
PROFITABILITY RATIOS
Return on Equity = Profit Margin Asset Yield Leverage
where ROE is Return on Equity
PM is Profit Margin
AY is Asset Yield
Lf is Financial Leverage
which can be stated as
ROE
[ PAT / E ]
PM
AY
Lf
= [ PAT / I ] [ I / A ] [ A / E ]
where PAT Profit after Tax

E
- Shareholders Equity
- Total Income
A - Total Assets
Return on Equity = Return on Assets Financial Leverage
where Return on Assets can be further expressed as

ROA = Profit Margin Asset Yield
Profit Margin is arrived at by dividing Profit after Tax by Total Income ( where
total income ( also called total operating income) is net interest income plus other
income. Profit Margin indicates the amount of profit (after tax) the bank is able to
generate for every Rial of income it earns. To arrive at Profit after tax from Total
Income
the major items to be deducted are
depreciation and loan loss provision.
staff & administration expenses,
Profit Margin is influenced by a banks cost
management and credit risk management practices. A bank which is able to control
its non-interest cost and which is able to keep loan losses low will show high profit
margin.
Asset Yield is arrived at by expressing Total Income as a percentage of
Total
Assets. Total income in turn is net interest income (interest income minus interest
expense) plus other income. Asset Yield is influenced by the banks interest rate risk
management practices and liquidity management practices and asset mix. If a bank
is able to maintain the spread between interest income and interest expense during
period of changing interest rates, its asset yield would be high. However if a bank is
unable to manage the impact of changes in the interest rate environment it would
experience a lowering of
asset yields.
Similarly the
banks asset mix and
percentage of assets in liquid low earning or non-earning assets would also influence
the asset yield. A bank with a higher level of liquid assets is normally expected to
earn less interest income and therefore a lower asset yield.
Financial Leverage (Lf) which is calculates as assets divided by equity indicates

capital account management practices of commercial banks. (Lf is reported not as a
% but as times).
Financial Leverage is the result of
a banks capital structure
decision. On the other hand some writers use Lf a measure of
financial risk.
While two banks may have the same operating profitability as indicated by ROA,
they may have different returns on equity depending on the managements capital
account management practices and how much of assets it would like to build for a
given level of equity. The bank which decides to maintain a higher leverage would
be able to report a higher ROE and would be rewarding it shareholders more, while
at the same time financial risk is higher.
Table 2.1
DUPONT MODEL
PROFITABILITY RATIO ANALYSIS
Ratios
Return on Equity
Profit Margin
Asset Yield
Leverage
Return on Assets
1997
27.7%
27.1%
8.4%
12.2
2.3%
1998
14.0%
24.4%
8.8%
6.5
2.2%
1999
9.6%
14.1%
9.0%
7.6
1.3%
2000
7.3%
10.3%
9.7%
7.3
1.0%
2001
-7.8%
-9.4%
8.4%
9.9
-0.8%
Bank B
Return on Equity
Profit Margin
Asset Yield
Leverage
Return on Assets
33.5%
34.7%
10.1%
9.5
3.5%
24.3%
31.2%
10.0%
7.8
3.1%
17.6%
26.4%
9.0%
7.4
2.4%
17.7%
24.9%
9.9%
7.2
2.5%
15.4%
20.2%
9.3%
8.2
1.9%
Bank C
Return on Equity
Profit Margin
Asset Yield
Leverage
Return on Assets
24.4%
25.5%
8.0%
12.0
2.0%
22.9%
20.4%
9.7%
11.6
2.0%
19.2%
17.4%
9.2%
11.9
1.6%
14.9%
13.0%
9.3%
12.3
1.2%
6.1%
6.4%
9.0%
10.6
0.6%
Bank D
Return on Equity
Profit Margin
Asset Yield
Leverage
Return on Assets
19.8%
31.8%
8.8%
7.0
2.8%
12.7%
18.6%
9.3%
7.3
1.7%
11.2%
14.6%
8.6%
8.9
1.3%
10.5%
13.3%
10.1%
7.9
1.3%
2.2%
3.1%
9.3%
7.6
0.3%
Bank E
Return on Equity
Profit Margin
Asset Yield
Leverage
Return on Assets
8.6%
16.9%
7.9%
6.4
1.3%
13.3%
22.4%
9.4%
6.3
2.1%
13.8%
22.2%
9.3%
6.7
2.1%
13.8%
20.8%
9.7%
6.8
2.0%
14.3%
20.2%
9.0%
7.9
1.8%
Bank F
Return on Equity
Profit Margin
Asset Yield
Leverage
Return on Assets
4.7%
18.2%
6.9%
3.8
1.3%
-24.6%
-62.1%
7.9%
5.0
-4.9%
Bank A
Profit margins of Omani commercial banks have tended to vary from one bank to the
other. For example in year 1997 one bank reported a profit margin as high as 60.7%
while in the same year another bank reported a PM of only 30.4%.
An analysis of the profit margin ratios of various banks over the period 1997 to
2001 shows that Bank B and Bank E (except in year 1997) have both been successful
in managing profit margins which also indicates that these banks probably have been
able to control they non-interest costs and loan losses well.
Asset yields of Omani commercial banks during the period 1997 to 2001 have been
varying in the range of 3.7% to 5.8%.
Analysis of asset yields of various commercial banks over the period 1997 to 2001
shows that some banks have consistently been able to
earn higher asset yields.
Specifically we find that Bank B and Bank D have higher asset yields of more than
5% in most of the five years for which the data was analysed. Good interest rate
risk management practices and asset mix decisions may be the reasons for these
banks ability to generate higher AY asset yields.
Financial leverage in the six Omani commercial banks during the period 1997 to
2001 have been in the range of 12.3 times (Bank C in year 2000)
to 5 times ( Bank
F in year 2001). Bank C in general has been following a practice of maintaining a

high leverage of around 12 ( assets are 12 times the equity) while Bank D and
Bank E have been following a policy of low leverage of around 7 to 8.
Obviously Bank C would therefore be able to generate a higher ROE compared to
the other banks for the same level of operational profitability ROA. For example
in year 1998, Bank C which had an ROA of 2.0% reported a ROE of 22.9%
while Bank E which had an ROA of 2.1 % reported an ROE of only 13.3%. If
we agree that shareholders and investors are ultimately interested in return on
equity3 ( ROE ) then Bank Cs performance is better. Bank C has been able to
Modigliani and Miller the well capital structure theorists argue that in world of perfect capital
markets without taxes financial leverage decisions are unimportant and it is return on assets which
determines investor return.
achieve this result because it had leverage ratio of 11.6 in that year as compared to
Bank Es leverage ratio of only 6.3.
Analysis of ROE trends in the six Omani commercial banks over the period 1997
to 2001 indicates that year 1997 was a good year for banks in general. Further the
ratios reported above also show that the good performance in 1997 was mainly due
to good profit margins generated by banks in that year.
Similarly year 2000 and
year 2001 ratios show that poor profit margins had a significant impact on return on
equity in these years. Asset Yield and leverage variations from year to year have
been less important. The conclusion therefore is that Omani banks should focus on
factors influencing
profit margins
like
cost management
and credit risk
management practices.
Profitability Analysis : Trends in Years 2002 & 2003
Profitability ratios based on the Dupont Model for year 2002 and 2003 are shown
in the table 2.2 shown below.
Compared to previous two years, Omani commercial banks in general have done
better during the years 2002 and 2003. They reported a return on equity of about
15 to 19 percent during this period. Only one bank reported losses during these
years.
Dupont analysis indicates that improved profit margins has definitely
contributed to the improved profitability.
Leverage figures have not changed
significantly during this period. There is a slight reduction in Asset Yields which
is expected given the downward trend in interest rates during 2002 and 2003. It is
interesting to note that quite a few banks have managed to improve profit margins in
spite of a general reduction in interest rates during this period. If one were to
look at the figures of
the one loss making bank (Bank A) one would notice
immediately this banks leverage and asset yield figures are similar to the other
banks. The loss appears to be due to negative profit margins. We again conclude
that Omani banks should focus on factors influencing profit margins like cost
management and credit risk management practices. However, the strategy of one
bank (Bank C) needs to be noted - the bank has been able to generate an ROE of
16.6% in 2002 although its profit margin was only 22.4% by good management of
leverage and asset yield.
Table 2.2
DUPONT MODEL
PROFITABILITY RATIO ANALYSIS 2002 2003
2002
2003
Ratios
Bank A Return on Equity
Profit Margin
Asset Yield
Leverage
Return on Assets
-0.27%
-0.34%
8.09%
9.6
-0.028%
-53.6%
-83.9%
7.1%
8.4
-5.9%
Bank B Return on Equity

Profit Margin
Asset Yield
Leverage
Return on Assets
18.7%
28.1%
7.8%
8.8
2.2%
19.4%
31.8%
7.23%
8.1
2.3%
Bank C Return on Equity

Profit Margin
Asset Yield
Leverage
Return on Assets
16.3%
18.9%
8.4%
10.1
1.6%
16.6%
22.4%
7.81%
9
1.7%
Bank D Return on Equity

Profit Margin
Asset Yield
Leverage
Return on Assets
19.3%
38%
7.4%
6.2
2.8%
12.8%
30.8%
6.6%
6.3
2%
Bank E Return on Equity

Profit Margin
Asset Yield
Leverage
Return on Assets
18.2%
27.5%
8.7%
7.2
2.4%
18.4%
31%
8%
7.5
2.5%
Bank F
- Merged -
Chapter 3
LIQUIDITY RISK MANAGEMENT
LIQUIDITY RISK MANAGEMENT RATIOS
Liquidity risk management refers to the ability of a bank to strike the right balance
between avoiding the problem of excess cash while at the same time ensuring that
the bank does not run into a problem of deficit cash. The word cash here means
currency held with the banks plus balances with CBO.
requirements
and other regulations of
the CBO
is
Taking care of reserve

also a part of
liquidity
management.
Whenever a bank is required to pay other banks because of a negative clearing

balance, such payments will typically be through debits to the banks own account
with the CBO. A banks treasury has to ensure that the funds available in the CBO
account are sufficient not only meet negative clearing balances but also are enough to
take care of the reserve requirements regulations of the CBO.
A bank maintaining a high level of
cash, that is excess cash suffers from a
problem of profit sub-optimization. More specifically the bank will be losing on

profit which it could have otherwise made, had its cash management been better. The
reason being that excess cash earns a zero interest. If such cash is invested in the
form of
commercial loans or securities then the bank would earn a return which
directly contributes to profit. Further we should also note that the cash is funded by
raising a deposits which have a cost in the form of interest paid to depositors.
To measure liquidity management policies of banks we use two ratios in this study:
LIQUIDITY MANAGEMENT RATIOS
Liquid Assets Ratio = Total Cash Resources / Assets * 100
where Total Cash Resources = Cash + Treasury Bills + Placements with Banks
Loans to Deposit Ratio = Loans / Deposits * 100
Liquid Assets Ratio indicates what percentage of assets a bank maintains in the
form of liquid assets which are available to meet any possible shortage of cash.
The ratio is based on the concept that a bank facing cash problems can easily convert
the T-Bills into cash or draw down on amounts lent to other banks in the inter-bank
market.
A low liquid assets ratio indicates that a bank is managing its liquidity
more profitably, but at the same time if the liquidity is too low there is a risk of
cash deficit.
Loan to Deposit ratio is an indicator of the ability of the bank to convert deposits
into loans. This ratio has a variety of meanings. From a liquidity point of view a
high loan to deposit ratio indicates a banks ability to manage with a low level of
cash and marketable investments. An implicit assumption here is that loans are more
profitable than investments ( in government securities and other securities).
Table 3.1
LIQUIDITY MANAGEMENT RATIOS OF
MAJOR COMMERCIAL BANKS IN OMAN :
YEAR 2001
Liquid Asset Ratio (%)
Loan to Deposit Ratio (%)
Bank A
12.00
137.62
Bank B
17.12
102.28
Bank C
16.08
120.39
Bank D
21.50
93.69
Bank E
14.19
98.15
Bank F
14.53
121.41
Year 2001 liquidity management ratios for the six local commercial banks in Oman
show that there is
different banks.
wide variation in liquidity management policies followed by
As shown in the table Bank D has liquid assets ( cash plus t-bills
plus placements with banks) which are 21.5% of total assets indicating a very high
level of liquidity, while Bank A which is operating in the same environment and
within the same regulations has liquid assets which are only 12 % of total assets.
The Loan to Deposit ratio leads us to the same conclusion, that Bank D is able to
deploy only 93.69% of its deposits as loans, while Bank As loans are 137.62%
in comparison to deposits.
Clearly Bank A prefers to hold a low level of liquid
assets while deploying as much funds as possible in the form of loans (which are
higher earning assets) while Bank D not only has high level of liquidity but also
lends much less in percentage of deposit terms.
Other things remaining the same
Bank D interest income would be lower, but in reality it is recognized that interest
income also depends on other factors such as interest rates, maturity mix and nonperforming loans.
Table 3.2
YEAR 2000
Bank A
12.94
147.44
Bank B
11.77
111.36
Bank C
18.86
119.92
Bank D
22.93
90.86
Bank E
15.43
100.76
Bank F
14.34
137.23
Year 2000 data give us a similar picture as the one in year 2001. Bank D has a
very high liquid asset ration and a low loan to deposit ratio again indicating that it is
the banks policy to be high on liquidity and low on loans. In year 2000 Bank B has
the lowest liquid assets ratio at 11.77 while Bank A also had a fairly low level of
liquid assets. While a low level of liquid assets ratio may be good from the point of
utilization of funds for lending there is always the risk that it may lead to situations
of cash shortage and the treasury of such banks has to be very adept at ensuring that
cash shortages are avoided.
It is interesting to further note that Bank B which had a low liquid asset ratio (of
11.77) has moved to a higher liquid asset ratio (of 17.12) in year 2001. At the same
time the banks loan to deposit ratio has come down from 111.36 in year 2000 to
102.28 in year 2001. The figures may indicate that the
following a policy of
lower level of
bank is deliberately
lending and the higher liquid assets ratio
might be just a consequence of this policy. Reasons for this change in policy may
be many - one of which could be that the bank feels that it is safer to deploy funds in
securities and the interbank market rather than go for high risk lending. Such
practices are common other countries. For example Canadian banks follow a
cyclical policy of high levels of lending when the market conditions are optimistic
and low levels of lending when market conditions are pessimistic.
Trends in Years 2002 & 2003

Table 3.3 and 3.4 reported below show the trends in liquidity management ratios
during
years 2002 and 2003.
There has been a general increase in liquid assets
ratio during this period compared to the earlier period of 2000 and 2001. In year
2003 as many three out of the five banks had a liquid assets ratio of more than 20,
with Bank D having a liquid asset ratio of 27%. Bank E has consistently followed a
low liquidity policy of around 15% through out this period.
During this period Loan to Deposit ratios have also come down with all banks
except one showing a less than 100 loan deposit ratio. Both the liquidity
management ratios seem to indicate that banks in general are parking funds in TBills and other liquid assets may be due to lack of demand for credit. One would
probably seen a change in these ratios once loan demand picks up.
Table 3.3
YEAR 2002
Bank A
14.57
123.13
Bank B
24.40
90.72
Bank C
14.37
119.26
Bank D
23.12
90.73
Bank E
15.08
96.02
Bank F
- merged -
Table 3.4
YEAR 2003
Bank A
20.08
99.80
Bank B
26.23
87.17
Bank C
15.13
115.49
Bank D
27.32
85.0
Bank E
14.81
99.62
Bank F
- merged -
Chapter 4
INTEREST RATE RISK MANAGEMENT
INTEREST RATE RISK MANAGEMENT RATIOS
Interest rate risk management refers to a managing risk posed by changing

interest rates which have a direct impact on
the interest earned on loans and
investments and the interest paid on deposits. Interest rate risk management is all
about managing the net interest margin ( interest income minus interest expense) and
controlling the risk posed by changing interest rates while trying to take advantage of
changing interest rates.
Even when interest rates change a bank can control interest rate risk by matching
the repricing maturities of assets and liabilities. If the both an asset and a liability
are repriced at the same time a bank will be able to maintain net interest margin as
interest cost and interest earnings either go up or down simultaneously.
However the realities of the market may be such that a bank may not be able to
match maturities of assets and liabilities. In Oman a typical banks faces a maturity
mismatch problem because deposits are short term in nature while loans are long term
in this market. This would result in a situation where deposits are repriced much
faster than loans (unless loans allow for faster repricing although their maturities are
long). In a situation where interest rates are falling this would be an advantage to the
banks. However if interest rates rise this would go against a bank which is financing
long term loans with short term deposits.
For banks operating in an environment of changing interest rates, which is the

situation in Oman over the last few years, interest rate risk management becomes a
key issue.
INTEREST RATE RISK MANAGEMENT RATIOS
Asset Interest Yield = Interest Revenue as % of Assets*
Break Even Yield = Interest Expense as % Assets*
Net Interest Margin = Net Interest Income as % of Assets*
Where net interest income is interest income minus interest expense
Cumulative Gap = Rates Sensitive Assets minus Rate Sensitive Liabilities

( 0 12 Months)
Cum gap / Assets = Cumulative gap as % of Assets*
* Average Assets ( = average of previous year and current year figures )
The above five ratios are used in this study to analyse the interest rate risk
management practices of commercial banks in Oman.
The first three ratios are
discussed first followed by a discussion on the second set related to gap management.
Asset Interest Yield gives us information about the average interest earned per Rial of
assets deployed by the bank while the Break Even Yield gives information about the
average interest expense the bank has to pay for generating funds for one Rial of
assets deployed. Net Interest Margin shows net interest income per Rial of assets
and is arrived at by deducting
Break Even Yield from Asset Interest Yield.
banks ability at managing interest rates is revealed by looking at the Net Interest
Margin.
As interest rates go up Asset Interest Yield as well s Break Even Yield
would also go up but not necessarily together as this depends on the maturity and
repricing profile of the assets and liabilities. If a bank is successful in interest rate
risk management we would find the Net Interest Margin would be steady whether
the interest rates are going up or down. If Net Interest Margin is shrinking this could
be an indication of poor interest rate risk management.
Cumulative Gap is a standard method of measuring the interest rate risk sensitivity
of a banks balance sheet. The higher the gap the more sensitive is the banks Net
Interest Margin to fluctuations in interest rates. Gap is calculated by first estimating
the Rate Sensitive Assets and Rate Sensitive Liabilities and netting one from the
other.
Gap can be calculated for different planning horizons - one month, three
month, six months, one year etc. In this study we analyse the one year (0 12
months) gap which shows the interest rate risk sensitivity to changes in interest rates
occurring over a period of one year. A positive gap indicates that a bank has more
rate sensitive assets than rate sensitive liabilities. A negative gap on the other hand
indicates that rate sensitive assets are less than rate sensitive liabilities.
The implications of gap to a banks profitability are as follows:

Change in Net Interest Income = Gap Expected change in Interest Rate
For example if bank has a negative gap of say RO 100 million and the change in
interest rates over the coming 12 months is say an increase of 2%, then the impact
is a decrease in net interest income by RO 2 million.
Change in Net Interest Income = -100 million +2% = -2 million
A decrease in net interest income by 2 million rials, other things remaining the same
would imply a decrease in profit for the year by 2 million.
Cum Gap as a % of Assets indicates the size of the gap in relation to the size of
the bank. It is accepted by banking experts that if this percentage is more than
10%, the gap could have a substantial impact on profitability if interest rates change
in an unexpected direction. To quote under most circumstances, the dollar interest
rate sensitivity Gap should not exceed 10% of the banks total assets over a one year
planning horizon4
Negative gap or positive gap in itself does not indicate that the bank is in a risky
position. The gap in conjunction with the expected change in interest rates is what
matters. A negative gap during a period of decreasing interest rates, and a positive
gap during a period of increasing interest rates are beneficial to the bank. However
a bank having a negative gap during a period of rising interest rates would stand to
make losses and is taking a risk.
Table 4.1
INTEREST RATE RISK MANAGEMENT RATIOS - I
YEAR 2000
Bank A
Asset Interest Yield Break Even Yield

(%)
(%)
( interest expense)
( interest revenue)
8.24
4.87
Net Interest Margin

(%)
(spread)
3.38
Bank B
8.27
4.34
3.93
Bank C
8.84
5.17
3.67
Bank D
8.06
4.52
3.54
Bank E
8.78
4.70
4.07
Bank F
7.90
4.15
3.75
The above table shows three interest rate risk management ratios for the year 2000.
Asset interest yield of the six banks are very similar with Bank C having the highest
yield at 8.84 and Bank F having the lowest at 7.90.
However Bank C also has the
highest interest expense as shown by the Break Even Yield indicating that it could
not take advantage of its high interest earning yield. Bank F which has the lowest
interest yield also has the lowest break even yield at 4.15.
In terms interest rate
management Bank E shows the best performance since it has the best Net Interest
Prefontaine, J & Thibeault A, Introduction to Bank Financial Management, Institute of Canadian

Bankers, 1993, page 126
Margin, in other words its spread management is the best of the six banks in year
2000.
Table 4.2
INTEREST RATE RISK MANAGEMENT RATIOS - I
YEAR 2001
Bank A

(%)
(%)
( interest expense)
( interest revenue)
7.77
4.02
Net Interest Margin

(%)
(spread)
3.75
Bank B
8.08
3.66
4.43
Bank C
8.11
4.41
3.70
Bank D
7.78
3.87
3.91
Bank E
8.79
3.75
5.04
Bank F
7.18
3.88
3.30
Three interest rate risk management ratios for year 2001 are shown in the table given
above. Interest yield variation is quite high in year 2000 compared to year 2000.
While in year 2000 inter bank variation was less than one percent in the year 2001
the interest variation is nearly 2 % ( lowest 7.18 and highest 8.79 ). Bank E in
particular managed to maintain the interest yield at 8.79% while many of the other
banks reported a decrease in interest yield. On the break even yield side (that is
interest expense) all the banks reported a lower level of break even yield.
In
particular Bank E managed to lower its interest cost to 3.75 almost one percent lower
than the previous year.
Bank E shows the best performance in terms of spread
management with a Net Interest Margin (NIM) of 5.04, followed by Bank B which
reported a NIM of 4.43. All other banks have a NIM less than 4 %.
Interest rate risk management of Bank E and Bank B are the best in both the years
inspite of the rapid fluctuations in interest rates in Oman during these two years.
(It is worth remembering here that asset interest yield ratio is based on interest
revenue which shows interest earnings net of reserved interest. Therefore interest
yield also depends on the credit risk management abilities of the bank and not just on
portfolio mix and maturity management.)
Table 4.3
INTEREST RATE RISK MANAGEMENT RATIOS II
YEAR 2000
Cumulative Gap
(0 12 months)
RSA RSL
(in millions)
Cum Gap / Assets

(%)
Bank A
-129
-15.7
Bank B
-67
-24.8
Bank C
-363
-28
Bank D
-92
-11.7
Bank E
-60
-22.5
Bank F
-16
-16.3
The above table shows the One Year Interest Rate Sensitivity Gap for different
commercial banks in Oman and the size of the gap in relation to assets.
All the
banks have a negative gap. However there are wide variations in the size of the gap.
Bank D is maintaining the lowest Gap/Assets % at -11.7% while Bank C has the
highest Gap/Assets % at -28%. As discussed earlier if interest rates increase by 2%
Bank C would stand to lose approx 7 million Rials ( -363 +2%) while if interest
rates decrease by 2 % the bank stands to gain 7 million in net interest income.
Compared to the norm that gap should not exceed 10% of
Oman have a high gap. Such a gap is necessarily risky.
assets all the banks in
Table 4.4
YEAR 2001
Cumulative Gap
(0 12 months)
RSA RSL
(in millions)
Cum Gap / Assets

(%)
Bank A
-67.27
-7.6
Bank B
n.a.
n.a.
Bank C
-439
-32.7
Bank D
n.a.
n.a.
Bank E
-53
-17.4
Bank F
-32.4
-25.1
For the year 2001 Gap information was not reported by two banks. Gap figures
reported by two of the remaining four banks show that the Gap/Assets % has
increased further as compared to year 2000. On the other hand Bank A has reduced
the gap significantly to 7.6 which is below the 10% norm. Bank C and Bank F gap
percentages are quite high at 32.7% and 25.1%.
One of the difficulties with
maintaining such a high negative gap is that the bank may not be able to reverse the
gap very quickly in case it expects an increase in interest rates during the coming
year.
In our earlier discussion on interest rate risk management using NIM ratio (net
interest margin) we concluded that Bank E and Bank B are the best as they have
managed to improve NIM during a period of fluctuating interest rates. However in
terms of
interest rate risk management as measured by Gap/ Assets % both the
banks are open to risk.
Using the gap measure one would say that Bank A is in a
low risk position while Bank E has reduced its gap risk by bringing down the gap %
from 22.5% in year 2000 to 17.4% in year 2001.
Trends in interest rate risk management during 2002 and 2003 can be seen in
the tables 4.5 to 4.8.
Comparing the interest rate management ratios with
the
earlier period one notices a decline in both Asset Interest Yield as well as a
decline in Break Even Yield. Asset Interest Yield has declined from around 8%
to 6% while Break Even Yield has fallen from around 4.5% to 2%. Since the
decline in Break Even Yield has been in general more than the decline in Asset
Interest Yield the net impact is an improvement in Net Interest Margins from
below 4% to above 4%. The change in Asset Yield, Break Even Yield and Net
Interest Margin has to be viewed in the light of a general decline in interest rates in
the Oman economy. These ratios indicate that banks have been able to manage
and overcome the interest rate risk created by declining interest rates.
The years 2002 and 2003 also show a clear change in the interest risk gap
management strategies of Omani banks.
For one, there has been a reduction in
the size of cumulative one year gap as shown the decline in Gap to Asset Ratio.
Further some banks have changed their
negative gap position into a positive gap
Example Bank D had a negative gap of - 92 million in year 2000 and this has
changed to a positive gap of +77 in year 2002 and +104 in year 2003. A positive
gap implies that this bank will benefit from an increase in interest rates. The
overall reduction in the size of the gap to below 10% for four out of the five
banks indicates a safe interest rate gap strategy.
Table 4.5
INTEREST RATE RISK MANAGEMENT RATIOS I
YEAR 2002
Bank A

(%)
(%)
( interest expense)
( interest revenue)
6.76
2.48
Net Interest Margin

(%)
(spread)
4.28
Bank B
5.92
4.16
1.76
Bank C
7.23
2.89
4.33
Bank D
6.14
2.13
4.01
Bank E
7.55
1.88
5.67
Bank F
- merged -
Table 4.6
INTEREST RATE RISK MANAGEMENT RATIOS I
YEAR 2003
Bank A

(%)
(%)
( interest expense)
( interest revenue)
5.84
2.5
Net Interest Margin

(%)
(spread)
3.34
Bank B
5.37
1.18
4.19
Bank C
6.53
2.13
4.41
Bank D
5.41
1.51
3.90
Bank E
6.77
1.54
5.22
Bank F
- merged -
Table 4.7
YEAR 2002
Cumulative Gap
(0 12 months)
RSA RSL
(in millions)
Cum Gap / Assets

(%)
Bank A
-214
-22.9
Bank B
n.a.
n.a.
Bank C
-290
-20.1
Bank D
77
11.8
Bank E
75
22
Bank F
- merged-
Table 4.8
YEAR 2003
Bank A
Bank B
Cumulative Gap
(0 12 months)
RSA RSL
(in millions)
Cum Gap / Assets

(%)
-72
-8.3
n.a.
n.a.
Bank C
-98
-6.3
Bank D
104
16.1
Bank E
21
5.1
Bank F
- merged -
Chapter 5
CAPITAL ACCOUNT
MANAGEMENT
CAPITAL ACCOUNT MANAGEMENT RATIOS
Capital account management refers to the ability of the bank to ensure that there is
enough capital both to satisfy the regulations as well as to provide an adequate
base for asset growth. Regulations require that every bank should have enough
capital to maintain the minimum capital adequacy requirement as defined by the
BIS (Bank of International Settlements) Capital Adequacy Ratio. Further we also
recognize that capital is required for asset growth. If a bank does not have enough
capital which is above the minimum required by the regulators, then further asset
growth will have to constrained or stopped by the banks management, as further
asset growth will worsen the Capital Adequacy Ratio.
To measure capital management policies of banks we use two ratios in this study:
Leverage Multiplier (Lf) = Assets as a % of Capital
where capital is same as Shareholders funds or equity
also called Asset to Equity Ratio
BIS Capital Adequacy Ratio = Total Capital Base as a % of Risk weighted

assets
Capital Assets Ratio = Capital as a % of Assets
Leverage multiplier is arrived at by dividing assets by capital or assets by equity.

It is a number which shows how much of assets the bank has created for
every
one
rial of
equity.
A high leverage indicates a higher level of risk
compared to a low leverage figure. Capital helps a bank to withstand the impact of
bad times when a bank faces losses. To the extent a bank is heavily capitalized its
ability to withstand the pressure of bad years is much more than a bank which is
thinly capitalized. Financial leverage multiplier (Lf) indicates the extent to which
Why Leverage helps a bank to improve its profitability
Consider two banks with the following simplified balance sheets

My Bank
Our Bank
Assets
Liabilities
Assets
Deposits = 2000
Assets = 3000
Equity =
Liabilities
Deposits = 5000
1000
Assets = 6000
Equity =
1000
My Banks Lf is 3 and Our Banks Lf is 6.
Assuming that for both the banks
earnings rate on assets is 10% and cost of
deposits is 5%, other income takes care of non interest expenses and tax rate is
50%, the Profit after Tax would be
My Bank
Our Bank
Income = 300
Income = 600
Deposit cost = 100
Deposit cost = 250
PBT = 200
PBT = 350
Tax = 100
Tax = 175
PAT = 100
PAT = 175
The figures
worked out using simplifying assumptions indicate that higher the
leverage the higher is the profitability.
a bank is willing to take risk. A low leverage figure indicates that the bank prefers
to follow a safe path as it grows, while a high leverage indicates that the bank is
following a risky policy. However a higher leverage helps a bank to improve its
profitability as shown the box above. At the same time, finance experts, say that
cost of
equity
is high compared to
cost of
deposits and therefore a banks
management may prefer to finance its asset growth with more of deposits and less
of capital (equity) which naturally results in a high leverage ratio.
The above
discussion brings out
the dilemma faced by bank management in
managing their capital account. Higher leverage improves profitability and cost of
equity is high compared to cost of deposits and therefore a banks management
would prefer to be high on deposits and low on equity. However, a low equity
implies a high leverage ratio which is risky. A bank with a high leverage ratio (
that is low capital to assets ratio ) faces the problem of solvency risk ( bankruptcy
risk) during periods of recession.
Table 5.1
YEAR 2000
Capital Asset Ratio
(%)
Bank A
Leverage
Multiplier (Lf)
(times)
6.94
BIS Capital
Adequacy Ratio
(%)
17.62
14.42
Bank B
6.58
18.00
15.20
Bank C
10.22
16.39
9.78
Bank D
8.37
16.03
11.95
Bank E
6.76
15.70
14.79
Bank F
3.21
26.44
31.14
The above table shows that all major commercial banks in Oman are well
capitalized by any standards, as shown by the BIS Capital Adequacy ratio. All the
banks are well above the 12% norm. In terms of
financial leverage policy the
figures show that while Bank C prefers a high leverage multiplier at 10.22,
BankF manages with a leverage ratio of 3.21. Other banks have leverage ratio
ranging between 6.5 to 8.37. The data clearly shows that Bank C is deploying
10.22 Rials of assets for every rial of capital.
While Bank Cs risk profile is
higher, it is also likely to be more profitable, other things remaining the same.
Table 5.2
YEAR 2001
Capital Asset Ratio
(%)
Bank A
Leverage
Multiplier (Lf)
(times)
8.22
BIS Capital
Adequacy Ratio
(%)
12.71
12.17
Bank B
7.32
17.00
13.67
Bank C
11.38
15.80
8.78
Bank D
7.75
16.93
12.90
Bank E
7.39
13.80
13.53
Bank F
4.28
19.62
23.35
Year 2001 shows that Bank C has continued its policy of higher leverage, while at
the same time maintaining a good BIS Capital Adequacy ratio. One may get a doubt,
whether it is really possible for a bank to have a good capital adequacy ratio while at
the same time having a high leverage, but one can see that it is possible as shown by
Bank C. Probably Bank C has been able manage its asset mix in such a way that it
deploys more of its assets in low risk weight assets.
In general for most of the banks leverage multipliers in Year 2001 are slightly
higher than year 2000.
Most of the banks continue to have a high Capital Adequacy ratio well above
the 12% norm. These ratios imply that major Omani commercial banks have room
for rapid asset growth without facing a capital constraint problem. However Bank A
might face a capital constraint problem very soon and may have to restrict asset
growth unless it is able to increase capital either through external financing or
retention of profits.
Table 5.3 and 5.4 show the capital account management ratios of Omani
commercial banks during the period 2002 and 2003.
change in the leverage ratios
There is no significant
and capital to assets ratios of
banks during this
period as compared to the earlier period. Bank C and Bank D experienced a slight
lowering of financial leverage ratio indicating their are not able to deploy as
much assets for every rial of capital as in the earlier periods.
BIS ratios
continue to be excellent for most of the banks. However as will be commented

later capital to assets ratios of
capital
for every
100 rials of
Omani commercial banks (at around 12 rials of

assets)
are
extremely
high
compared to
international average which is below five (which would imply an leverage ratio (Lf)
of more than 20). Omani banks are not able to use financial leverage to their
advantage as compared to banks in other countries. Better leveraging would help the
banks to improve profitability and reduce spreads.
Table 5.3
YEAR 2002
Capital Asset Ratio
(%)
Bank A
Leverage
Multiplier (Lf)
(times)
9.59
BIS Capital
Adequacy Ratio
(%)
13.31
10.42
Bank B
8.79
19.70
11.38
Bank C
10.08
16.05
9.92
Bank D
6.22
24.06
16.07
Bank E
7.26
Bank F
- merged -
14.30
13.78
Table 5.4
YEAR 2003
Capital Asset Ratio
(%)
Bank A
Leverage
Multiplier (Lf)
(times)
8.4
BIS Capital
Adequacy Ratio
(%)
18.26
11.91
Bank B
8.14
20.04
12.29
Bank C
8.98
16.39
11.13
Bank D
6.29
24.96
15.90
Bank E
7.51
15.06
13.32
Bank F
- merged -
Chapter 6
CREDIT RISK MANAGEMENT
CREDIT RISK MANAGEMENT RATIOS
Credit risk is a an important part of bank management. Credit risk is the risk
that a financial contract will not be honoured according to the original set of terms or
expectations.
Credit risk occurs whenever a bank lends money or invests in
securities. Whenever a bank lends and for some reason finds that repayments and
interest payments are not taking place, there is double impact on the banks
finances. One, bank will have to stop accruing interest on the doubtful loans and
therefore there is an immediate income loss to the bank. Second, the bank will have
to make provisions for the non performing loans and this has to be made from the
net interest income which the bank is currently earning, which implies that profit
will be reduced.
In this study three measures of credit risk are used :

Total Loan Loss Provisions as % of Loans
where total loan loss provision indicates balance in the loan loss provision account which
includes not only current year provisions but also previous provisions adjusted for write offs
and recoveries
Risk Adjusted Margin (RAM)% =

{ Net Interest Income + other Income Provision for Credit Losses } / Average Assets
where net interest income = interest income minus interest expenses and provisions for
credit losses indicates provisions made during the year
Non Performing Loans to Loans %
The first ratio shows total loan loss provisions as a percentage of loans and reflects
the credit risk of the bank. Non performing loans to loans is a similar measure of
credit risk.
Risk Adjusted Margin (RAM) is a measure which shows the impact of credit risk on
the profitability of the bank. Specifically it is calculated as net interest income plus
other income minus provisions made during the year for loan losses divided by
assets.
When compared with the Net Interest Margin (NIM)
figure it shows the
impact of loan losses on the bank. RAM rather than NIM is a true reflection of the
risk management abilities of the bank, because it shows the spread ( or margin)
net of loan loss provisions.
process of
Further it shows the risk faced by the bank in the
managing its credit portfolio.
If
one were to measure a banks
management abilities only using NIM it would show only the interest income
generation net of interest expense but it would not show the attendant risks. A bank
can increase its NIM by giving high interest loans, but if the high interest loans
carry a higher risk this would not get reflected in NIM. On the other hand RAM
reflects this risk to the extent higher risk results in higher provisions.
Table 6.1
YEAR 2000
Risk Adjusted
Margin (%)
NPL to Total Loans

(%)
Bank A
Total Loan Loss

Provisions as % of
Total Loans
6.79
3.5
9.25
Bank B
2.37
5.66
5.73
Bank C
3.13
3.54
7.91
Bank D
5.94
3.99
14.66
Bank E
5.21
4.84
1.71
Bank F
0.37
4.53
1.04
The above table shows the credit risk management ratios for year 2000.
The
figures show that credit risk experience of different banks varies from each other.
While some banks reported 6.69% total loans loss provisions as percentage of total
loans there are other banks which reported a figure of just 2.37% and one bank
whose figure was only .37%.
The performance of the banks in terms of Risk Adjusted Margin (RAM) has in
general been good with the RAM figures ranging from 3.5 to 5.66. The figures
show that in general banks have done a good job of
managing their credit
portfolio since as we said earlier RAM reflects net interest margin plus other income
net of loss provisions. RAM also shows what is available to meet the non-interest
expenses ( like staff and administration expenses) and profit expectations of the
shareholders. Just for the purposes of comparison, one could compare the above
figures with say Canadian Banks. Canadian banks reported RAM figures in the
range of 2.26 to 3.82.
Another aspect also worth noting is that the bank with the highest RAM (Bank B at
5.66 ) does not have the highest Asset Interest Yield (Bank Bs asset interest yield
is only 8.27 - figures reported in interest ratios table above) implying that the bank
followed a policy of lower return loans with a lower risk, but still managed to
achieve a high risk adjusted margin.
Table 6.2
YEAR 2001
Risk Adjusted
Margin (%)
NPL to Total Loans

(%)
Bank A
Total Loan Loss

Provisions as % of
Total Loans
10.68
1.5
18.78
Bank B
3.62
5.43
5.86
Bank C
5.66
2.67
10.36
Bank D
8.40
2.82
21.33
Bank E
6.92
4.89
1.69
Bank F
9.47
-3.02
15.52
In year 2001 most of the banks reported a higher level of loan loss provisions as
compared to year 2000 reflecting the impact of external environment on all banks
in general. As expected the Risk Adjusted Margins were also lower reflecting the
credit risk
pressure under which most banks
were operating.
However it is
interesting to note that even though the external environment in general affected all
the banks, some banks like Bank B managed to maintain a high RAM at 5.43.
The year 2001 experience brings out the importance of
prudent capital account
management. Year 2001 was year of credit risk problems, however all the banks
sailed through the year with BIS Capital Adequacy Ratios of 12 % + indicating
that their excellent capital strength helped them to ride through the bad patch.

Trends in credit risk management ratios during the period 2002 and 2003 are
shown in tables 6.3 and 6.4 .
Of the five banks three banks show a general
reduction in Loan Loss Provisions to total assets ratio and a general decline in Non
Performing Loans indicating a definite improvement in credit quality. Bank A
shows an increasing trend in these two ratios to alarming levels. Bank D has been
able to contain the credit risk problem and is coming out of
the woods.
Risk
Adjusted Margins improved considerably for four banks in 2003 again a indication
of
general improvement in asset quality.
If one were to make international
comparisons, one can conclude that NPLs to total loans are high in
our
commercial banks compared to banks in other countries. Improving asset quality is

definitely an important task in front of the countries commercial banks.
Table 6.3
YEAR 2002
Risk Adjusted
Margin (%)
NPL to Total Loans

(%)
Bank A
Total Loan Loss

Provisions as % of
Total Loans
11.02
1.83
30.84
Bank B
2.57
5.33
8.93
Bank C
4.65
4.07
9.98
Bank D
5.42
4.39
23.27
Bank E
5.35
5.34
5.64
Bank F
- merged -
Table 6.4
YEAR 2003
Risk Adjusted
Margin (%)
NPL to Total Loans

(%)
Bank A
Total Loan Loss

Provisions as % of
Total Loans
20.16
-3.54
51.78
Bank B
3.13
5.37
8.40
Bank C
5.32
4.28
9.11
Bank D
5.66
4.15
20.44
Bank E
5.84
5.48
9.62
Bank F
- merged -
Chapter 7
COST MANAGEMENT
COST MANAGEMENT RATIOS
Cost management refers to issues related to management of non interest

expenses like staff expenses and administration expenses. Good cost management
helps a bank in improving its long run profitability. Good cost management helps
a bank in improving its productivity and
reducing its Overhead Burden. If a bank
manages to control its costs, it can become a low cost producer of
financial
services and therefore has the ability to follow aggressive pricing strategies. Further
lower costs reduce the overhead risk and improves the banks ability to withstand
periods of low business turnover and periods of heavy competition.
In this two measures of cost management are used:

Overhead Burden Ratio (%) =
{Non-Interest Expenses Other Income} / Net Interest Income
reported as percentage
Productivity Ratio (%)=
{Non-Interest Expenses} / {Net Interest Income + Other Income)
also called the Cost to Income Ratio

reported as a percentage
Overhead burden ratio shows the expense burden (net of other income) on the
banks net interest income. In an ideal situation if all the non-interest expenses are
taken care of by other income a bank would have zero overhead burden ratio and
the bank would be in a position to adopt aggressive pricing strategies in order to
attract business and in dealing with competition.
Productivity or cost / income ratio is the most popular ratio to analyse cost
management in banking. The ratio is simple to interpret : it shows the cost
involved in producing one Rial of income. If a banks staff , admin and other costs
are high then the cost involved in producing one Rial of income would be high,
and therefore cost productivity would be seen to be low. It is important to note the
interest cost has already been netted out in arriving at the net interest income and
therefore interest cost does not get reflected in this ratio. The ratio focuses on noninterest costs. The ratio is also called productivity ratio - the lower the ratio the
higher is the productivity.
Table 7.1
YEAR 2000
Overhead Burden Ratio*
(%)
Bank A
17
Productivity Ratio*
(%)
[ also called
Cost / Income Ratio ]
41
Bank B
29
52
Bank C
39
50
Bank D
30
49
Bank E
28
44
Bank F
41
54
* the smaller this ratio is, the better the performance
The above table shows the cost ratios of major Omani commercial banks in the year
2000. Overhead burden ratios have varied quite a lot between different banks as
shown by the data in the table. Bank A has the lowest Overhead Burden Ratio at
17% while Bank F has the highest at 41%. Bank As 17% reflects that non-interest
expenses net of other income accounted only for 17% of net interest income for the
bank, indicating that most of the non-interest expenses were taken care by other
income which would enable the bank to compete effectively and also to follow
aggressive pricing strategies.
Productivity ( or cost / income ) ratio has varied between 41%
and 54% during
year 2000. Bank A achieved the best productivity ratio at 41%, that is, its cost to
income was the lowest. This figure indicates that to produce one rial of income the
bank spent 410 baisa.
The extent of variation in cost/income ratio between
different banks is not very high, and the ratios themselves are not very high
indicating good cost management practices.
Table 7.2
YEAR 2001
Overhead Burden Ratio
(%)
Bank A
20
Productivity Ratio
(%)
[ also called
40
Bank B
20
44
Bank C
31
44
Bank D
41
54
Bank E
31
44
Bank F
53
63
Year 2001 Overhead burden ratios of different banks varied between 20 to 41 if one
were to ignore Bank F which had a high figure. In terms of productivity or
cost/income the figures have varied between 40 to 54 if one were to again ignore
Bank F which seems to be an outlier. In general, productivity levels are very
uniform with most banks having a ratio around 40 to 44. The figure indicates that a
typical Omani bank spends 400 baisa to produce one rial of income.
By international standards Omani banks have low cost / income ratio ( or to say
Omani banks have good productivity ratios). Data reported by Banker Magazine
for year 2001 shows that most Asian, American and European banks have cost /
income ratios in excess of 52% ( generally between 60 to 70% )
The conclusion is that in terms of cost management the performance of Omani

commercial banks
is
excellent,
and that
these
banks have high levels of
productivity.
Cost management ratios of commercial banks in Oman in the years 2002 and 2003
are shown in tables 7.3 and 7.4.
The cost to income ratio or the productivity
ratio of banks continues in the ratio of 40 to 50 except in case of
one bank.
Bank E continues to have a low cost to income ratio indicating excellent cost
management practices which probably contributed to its excellent Return on Equity.
By international standards banks in Oman continue to have low cost to income
ratios indicating good cost management and high productivity.
Table 7.3
YEAR 2002
(%)
Bank A
18
Productivity Ratio*
(%)
[ also called
38
Bank B
27
50
Bank C
33
47
Bank D
38
53
Bank E
25
38
Bank F
- merged -
Table 7.4
YEAR 2003
(%)
Bank A
31
Productivity Ratio*
(%)
[ also called
50
Bank B
27
49
Bank C
29
45
Bank D
44
57
Bank E
28
42
Bank F
- merged -
Chapter 8
For the purpose of comparison of
financial ratios achieved by major Omani
commercial banks with those of banks located in developed countries we use data
on ratios reported by The Banker5 journal in its report on top world banks.
Unlike the financial ratio analysis reported above
which looked into a variety of
issues such as profitability, liquidity, interest rate risk, capital account, credit risk,
cost management etc and is based on a large number of ratios ( 19 ratios), the Banker
data is limited to about 6 ratios which look into only some of these aspects.
The 19 ratios discussed in the earlier sections include the six ratios reported by the
Banker.
In order to compare therefore we report the data of our six Omani commercial
banks along with the banks into other countries only on those aspects reported by The
Banker. While we do believe that 19 the ratios discussed earlier in the study throw
more light and allow for a more detailed analysis of banks, in this section the
analysis is constrained by the availability of data.
One problem which we would like straight away point out in doing international
comparisons is the fact that the banks in various countries are not comparable in size
to banks in Oman and therefore while making comparisons this fact should be kept
in mind. Further comparisons are done only for the year December 2001.
The Banker published by Financial Times Business Ltd, London - July 2002
Table 8.1: International Comparisons

Bank
Capital
Pre-Tax
Return
Cost
Assets
Profit on
on
Ratio
Avg
Assets
Capital
(Pre-
Tax) %
BIS
NPL
Income
Capital
to
Ratio %
Ratio
Total
Loans %
Oman
Bank A
12.1
-5.9
-0.64
40.5
12.71
16.5
Bank B
13.6
17.6
2.3
44
17
5.4
Bank C
8.7
8.0
0.68
44.2
15.8
9.4
Bank D
12.9
2.8
0.38
53.9
16.9
18.6
Bank E
13.5
16.3
2.2
44
13.8
1.6
Bank F
23.3
-24.2
-5.6
53
19.6
13.5
HSBC Holding
5.0
23.5
1.16
56.42
12.99
3.0
Royal Bank of Scotland
4.2
31.5
1.19
63.88
11.52
Na
HBOS
4.5
Na
.95
51.99
10.55
2.06
Barclays Bank
3.5
31.4
1.04
57.87
12.5
2.44
Deutsche Bank
2.70
7.8
0.20
90.45
12.10
4.8
HypoVereinsbank
2.98
7.2
0.21
78.70
10.80
Na
Commerzbank
2.43
0.3
0.01
84.71
10.30
0.28
Scotiabank
5.56
22.2
1.16
55.13
13
2.40
Royal Bank of Canada
4.25
27.2
1.10
66.22
11.79
1.10
Bankof Montreal
4.21
15.8
0.66
73.7
12.01
1.13
National Australia Bank
5.94
22.7
1.23
65.66
10.16
0.87
ANZ Banking Group
6.24
27.8
1.67
48.58
10.31
1.31
Commonwealth Bank Grp
4.82
36.5
1.82
58.59
9.16
0.74
United Overseas Bank
11.24
12.3
1.06
39.3
18.5
9.3
DBS Bank
6.92
13.2
0.90
52.83
17.4
4.0
Overseas Chinese Bkg Corp
7.59
13.3
1.15
39.02
18.8
9.81
United Kingdom
Germany
Canada
Australia
Singapore
A close look at the above data throws up a number of trends.

9 Cost to Income Ratio which is an indicator of productivity (it shows the
cost involved in producing one Rial of income the lower the ratio the higher
is productivity). All Omani commercial banks have a lower cost to income
ratio as compared to banks in developed countries (except Singapore). This
indicates that banks in Oman have a higher productivity as compared to banks
in other countries.
9 BIS Capital Adequacy ratio of commercial banks in Oman is high compared
to banks in other countries indicating good levels of capitalization.
9 Non Performing Loans to Total Loans is high is case of four banks while
two Omani banks reported a low level of non performing loans as compared
to banks in other countries. However we agree that year 2001 was a difficult
year for banks in Oman.
9 The impact of non-performing loans on profitability (Pre tax profit to average
capital) can be readily seen.
9 Capital Assets Ratio (which reverse of Leverage ratio) of commercial banks
in Oman is generally high (expect in the case of Bank C) as compared to
banks in developed countries. While capital assets ratio in Oman is generally
in the range of 12 to 14, in case of
developed countries this ratio is
averaging around 5 to 6. As pointed out in the profitability ratios part of the

study which analysed the data from 1997 to 2001 and in the capital account
management part of the study capital asset ratio have tended to remain
steady over the years, that is around the level of 12 to 14.
9 We can therefore definitely conclude that banks in
Oman can in general
examine the possibility of increasing their capital asset ratios in line with
international banks. This would enable them to improve return on equity /
profitability further.
Chapter 9
CONCLUSIONS
CONCLUSIONS
Dupont Analysis: ROE of the six Omani commercial banks has been varying a lot
over the period 1997 to 2003 ( from 28% to -53%). The Dupont model tries to
explain the variations in ROE (profitability) through Profit Margin, Asset Yield and
Leverage ratios.
Analysis of ROE trends in the six Omani commercial banks over the period 1997
to 2003 indicates that year 1997 was a good year for banks in general. Further the
ratios reported above also show that the good performance in 1997, 2002 and 2003
was mainly due to good profit margins generated by banks in those years.
On the
other hand year 2000 and year 2001 ratios show that poor profit margins had a
significant impact on return on equity in these years.
Asset Yield and leverage
variations from year to year have been less important. The conclusion therefore is
that Omani banks should focus on factors influencing profit margins like cost
management and credit risk management practices.
Liquidity Management: While some banks have been consistently following a policy
of low liquidity (liquid asset ratio of 12% to 15%) there are other banks which are
operating in the same environment and within the same regulations which maintain
liquidity levels as high as 26%. Liquid asset ratios of
banks have in general
increased over the period.
Interest Rate Risk Management: Net Interest Margins (spreads) have varied in the
range of 3.3% to 5.67%. Most banks reported NIM in the range of 3.5% to 4.5%.
Although year 2001 was not a good year in terms of profitability all banks reported
good net interest margins indicating interest rate management was not the reason for
poor profitability.
One year Cumulative Gap / Assets ratio is high for Omani banks compared to
international standards. In 2001 all banks reported negative gaps with some banks
having negative gaps ratios as high as 24, 25 & 32%. Such gaps are necessarily risky
especially if interest rates are likely to rise. Year 2003 saw a significant change in
banks gap strategy ( Gap/ Asset ratio started declining).
Capital Account Management Ratios: All banks have good BIS capital adequacy
ratios well above the 12% norm. A few banks are not only able to maintain a high
capital adequacy ratio but also leveraging well with leverage ratios of 11+ (or a
capital asset ratio of around 9 ). Compared to international banks, most Omani
banks have low leverage multipliers ( that is high level of capital to asset in the range
of 12% to 23% compared to banks in developed countries which have capital asset
ratio of around 5%).
Credit Risk Management: Total Loan Loss Provisions to Total Loans
were high in
years 2001 & 2002 in the range of 5 to 10%, and as expected Risk Adjusted Margins
were lower. The year 2001 experience brings out the importance of prudent capital
account management. Year 2001 was a year of credit risk problems, however all
banks sailed through because of their excellent capital strength. By year 2003 there is
general improvement in asset quality (except in case of one bank )
Cost Management : Banks in Oman report cost / income ratios in the range of 38%
to 54%. By international standards Omani banks have low cost / income ratios
indicating good productivity.
REFERENCES
REFERENCES
Altman E.I., Caouette, J.B. & Narayanan S.S., Managing Credit Risk, John Wiley,
1998
Davies, Dick, Finance and Financial Management, University of Strathclyde
Graduate School of Business, 2002
DeYoung, Robert, De Novo Bank Exit, Journal of Money Credit & Banking,
October, 2003
Gujarati, D.N., Basic Econometrics, McGraw-Hill, 1995
Johnson, F.P. & Johnson R.D., Bank Management, American Bankers Association,
1983
Koch T.W & Mac Donald S.S., Bank Management, 5e, Thomson / South-Western,
2003
Mishkin F.S. & Eakins S.G., Financial Markets & Institutions, Addison-Wesley,
1998
Prefontaine, J & Thibeault A, Introduction to Bank Financial Management, Institute
of Canadian Bankers, 1993
Rose, Peter S, Commercial Bank Management(4th ed), Irwin/McGraw-Hill, 1999
Saunders, A., Financial Institutions Management, 3e, Irwin MacGraw Hill, 2000
Sinkey, J. F., Commercial Bank Financial Management, Macmillan, 1989
The Banker published by Financial Times Business Ltd, London - July 2002
Uyemura, D.G. & Van Deventer D.R, Financial Risk Management in Banking: The
Theory & Application of Asset Liability Management, BankLine/Irwin (Bank
Administration Institute Foundation), 1993

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All in-text references underlined in blue are linked to publications on ResearchGate,

Available from: Sree Rama Murthy Y

RESEARCH STUDIES 2003

College of Banking & Financial Studies

banks with those in other countries (although such

The banks included in the study are:

The second part of

the study compares the performance of

The ratios used in the study are :

Loan to Deposit Ratio(%)

Liquidity risk management ratios

what bank financial management is all about.

Prefontaine, J & Thibeault A, Introduction to Bank Financial Management, Institute of Canadian

Profitability can be measured by a variety of ratios depending on the purpose of the

Return on Assets is another good measure of performance and profitability. However

where PAT Profit after Tax

Return on Equity = Return on Assets Financial Leverage

where Return on Assets can be further expressed as

the major items to be deducted are

depreciation and loan loss provision.

staff & administration expenses,

Profit Margin is influenced by a banks cost

Asset Yield is arrived at by expressing Total Income as a percentage of

banks asset mix and

Financial Leverage (Lf) which is calculates as assets divided by equity indicates

Financial Leverage is the result of

a banks capital structure

decision. On the other hand some writers use Lf a measure of

earn higher asset yields.

F in year 2001). Bank C in general has been following a practice of maintaining a

Similarly year 2000 and

and credit risk

Profitability Analysis : Trends in Years 2002 & 2003

Dupont analysis indicates that improved profit margins has definitely

contributed to the improved profitability.

Leverage figures have not changed

the one loss making bank (Bank A) one would notice

Bank B Return on Equity

Bank C Return on Equity

Bank D Return on Equity

Bank E Return on Equity

LIQUIDITY RISK MANAGEMENT RATIOS

and other regulations of

Taking care of reserve

Whenever a bank is required to pay other banks because of a negative clearing

A bank maintaining a high level of

cash, that is excess cash suffers from a

problem of profit sub-optimization. More specifically the bank will be losing on

Liquid Assets Ratio = Total Cash Resources / Assets * 100

Loans to Deposit Ratio = Loans / Deposits * 100

Loan to Deposit Ratio (%)

wide variation in liquidity management policies followed by

Clearly Bank A prefers to hold a low level of liquid

Other things remaining the same

Loan to Deposit Ratio (%)

lending and the higher liquid assets ratio

Trends in Years 2002 & 2003

years 2002 and 2003.

There has been a general increase in liquid assets

Loan to Deposit Ratio (%)

Loan to Deposit Ratio (%)