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Chapter 6

FIN 3120 Chapter 6: CH 6 Measuring and Evaluating the Performance of Banks and their Principal Competitors

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University of Denver
FIN 3120
Chi Hung Leung

CH 6: Measuring and Evaluating the Performance of Banks and their Principal Competitors Most important dimensions of performance: profitability and risk A fair evaluation of any financial firms performance should start by evaluating whether it has been able to achieve the objectives its management and stockholders have chose o Maximize the value of the firm The minimum acceptable rate of return, r is referred to as an institutions cost of capital Profitability Ratios: o ROE o ROA o Net interest margin o Net noninterest margin (slide 6.7) o Net operating margin o Earnings per share of stock (EPS) o Earnings spread o Equity multiplier o Asset utilization ratio Keys to Superior Profitability: Use of financial leverage: proportion of assets financed by debt as opposed to equity capital Use of operating leverage: proportion of fixedcost inputs used to boost operating earnings as output grows Control of operating expenses: so that more dollars of sales revenue become net income Management of the asset portfolio: to meet liquidity needs while seeking the highest returns from any assets acquired Control of exposure to risk: so that losses dont overwhelm income and equity capital Measuring Risk in Banking and Financial Services: Risk to the manager of a financial institution or to a regulator supervising financial institutions means the perceived uncertainty associated with a particular event o The higher the standard deviation or variance of the above measures, the great the overall risk o Credit Risk: probability that some of the financial institutions assets will decline in value and perhaps become worthless o Liquidity Risk: probability the financial firm will not have sufficient cash and borrowing capacity to meet deposit withdrawals and other cash needs o Market Risk: probability of the market value of the financial firms investment portfolio declining in value due to a change in interest rates o Interest Rate Risk: the danger that shifting interest rates may adversely affect a banks net income, the value of its assets or equity o Capital Risk: probability of the value of the banks assets declining below the level of its total liabilities o Operational risk: the uncertainty regarding a financial firms earnings due to failures in computer systems, errors, misconduct by employees, floods, o Legal and compliance risk o Reputation risk
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