Asset & Liability

Asset & Liability for bank is defined as:

Major Asset:
Loans to individuals, business and other organizations
The securities that it holds

Major Liability:
Deposits
Money that it borrows, either from other banks or by
selling commercial paper in the money market

Bank Earnings
Interest and fees on loans is traditionally the major
source of income for commercial banks.
Interest paid on deposits is one of the largest expense
items.
Both of the above follow market rates of interest.
Net interest income represents the difference between
gross interest income and gross interest expense

Bank Earnings: Non Interest

Noninterest income includes fees and service charges.
This source of revenue has grown significantly in
importance.
Non interest expense includes salary expenditures.
These expenses have also grown in recent years

Bank Performance
Trends in profitability can be assessed by examining
Return on Assets(ROA) over time.
Another measure of profitability is Return on Equity.
Other measures that are widely used are Risk Adjusted
Return on Capital (RAROC) and Economic Profit
(Economic Value Added).

Return on Asset (ROA)

Return on Asset =
(Free income + Net interest income operating cost)/
Average total assets
Or

Return on Asset =
Net income/Average total asset
It tells that what an bank is earning on its total asset.

Net Interest Income

Net Interest Income =
Interest Received on Assets-Interest Paid on Liabilities
Or

Net Interest income =

Interest Earned on Securities & Loans- Interest Paid on
Deposits and Borrowings

High net interest income and margin indicates a well

managed bank and also indicates future profitability.

Interest Rate Spread

Net interest income depends partly on theinterest rate
spread
Interest Rate Spread =
Average Interest Rate Received on Assets Average Interest Rate
Paid on Liabilities

Interest rate spread is difference between the average

yield a financial institution receives from loans and
other interest-accruing activities and the average rate it

Net Interest Margin

It shows how well the bank is earning income on its assets.
Net Interest Margin =
Net Interest Income / Average total assets
Where,
Average Total Assets=
(Total Assets at End of Fiscal Year +Total Assets at Start of
Fiscal Year)/2

Return on Equity(ROE)
ROE=Return on AssetsxLeverage Ratio
Or
ROE= Net Income/Bank capital
Where,
Leverage Ratio = Bank assets/ Bank
capital

Return on Equity(ROE)
The Return on equity is what the bank's owners are primarily interest
in because that is the return that they earn on their investment.
When a bank increases its liabilities to pay for assets, it is using
leverage otherwise a bank's profit would be limited by the fees that it
can charge and its interest rate spread.
Interest rate spreads are not wide and so a bank can only earn more
net interest income by increasing the number of loans that it makes
compared with the amount of its bank capital which it does by using
leverage.

Profitability Analysis
It decomposes cost management and revenue management into
narrower categories of cost and revenue to evaluate the source of
profits. It includes:
Assets utilization
Determination of net interest income.
Efficiency ratio
Analysis of non interest expense.
Determination of net interest expense.
Profit vs. risk

Asset Utilization
Asset utilization =
(non interest revenue/assets ) + (interest revenue/assets)
It Involves:

Rate

Composition

Volume effect

Determination of Net Interest

Income
It involves Interest Earning assets as a share of
assets which include:
Volume Effects = earning assets/total assets
Composition/Mix Effects: Types of interest earning
assets.

Analysis of Non Interest

Expense
It include:
Personnel Expenses
Total Expenses
Burden

Profit v/s Risk

Earning high profits in good or even normal
times will be easier if the bank is willing to
take on some risk.
This risk may be more problematic in bad
times.
Important to measure the risk of the banking
system as well as the profits.