Write about at least five key financial ratios used in analyzing the financial statements of a bank
Financial ratio analysis is the most widely used tool for evaluating a bank’s financial health and performance. Regulators, investors, and bank management use these ratios to assess profitability, asset quality, liquidity, capital strength, and operating efficiency.
Have a look at five key financial ratios:
Capital Adequacy Ratio (CAR)
CAR = (Tier 1 Capital + Tier 2 Capital) ÷ Risk-Weighted Assets × 100
Meaning: The Capital Adequacy Ratio measures a bank’s ability to absorb unexpected losses from its own capital. It protects depositors by ensuring that the bank has sufficient capital to withstand financial shocks.
Interpretation: Bangladesh Bank requires banks to maintain a minimum CAR of 10% or Tk. 400 crore, whichever is higher. A higher CAR indicates a stronger and more financially resilient bank.
Non-Performing Loan (NPL) Ratio
NPL Ratio = Classified Loans ÷ Total Loans × 100
Meaning: The NPL Ratio measures the quality of the bank’s loan portfolio. It shows the percentage of loans that have become non-performing.
Classified loans include Substandard, Doubtful, and Bad/Loss loans.
Interpretation: A high NPL Ratio reduces interest income. It also increases provisioning expenses and weakens the bank’s capital position. According to Bangladesh Bank, an NPL Ratio below 5% is generally considered healthy.
Return on Assets (ROA)
ROA = Net Profit After Tax ÷ Average Total Assets × 100
Meaning: Return on Assets measures how efficiently a bank uses its assets to generate profit.
Interpretation: A higher ROA indicates better utilization of assets. For commercial banks, an ROA between 1.0% and 1.5% is generally considered satisfactory.
Return on Equity (ROE)
ROE = Net Profit After Tax ÷ Average Shareholders’ Equity × 100
Meaning: Return on Equity measures the return earned on the shareholders’ invested capital.
Interpretation: A higher ROE indicates better returns for shareholders. However, an unusually high ROE may result from excessive financial leverage rather than improved performance.
Net Interest Margin (NIM)
NIM = (Interest Income − Interest Expense) ÷ Average Earning Assets × 100
Meaning: Net Interest Margin measures the profitability of the bank’s core lending and borrowing activities.
Interpretation: A higher NIM indicates that the bank earns more interest from loans than it pays on deposits. It also reflects effective pricing and sound Asset-Liability Management (ALM).
Provision Coverage Ratio (PCR)
PCR = Loan Loss Provisions ÷ Gross NPLs × 100
Meaning: The Provision Coverage Ratio measures the extent to which non-performing loans are covered by loan loss provisions.
Interpretation: A PCR of 100% means that the bank has fully provided for all gross non-performing loans. This indicates stronger protection against potential loan losses.
Cost to Income Ratio (CIR)
CIR = Operating Expenses ÷ Net Operating Income × 100
Meaning: The Cost to Income Ratio measures the bank’s operating efficiency.
Interpretation: A lower CIR indicates greater operating efficiency. For commercial banks, a ratio below 50% is generally considered efficient.
Debt to Equity Ratio (D/E)
D/E Ratio = Total Liabilities ÷ Shareholders’ Equity
Meaning: The Debt to Equity Ratio measures the bank’s financial leverage. It shows the extent to which the bank relies on borrowed funds compared with shareholders’ equity.
Interpretation: Banks naturally operate with high leverage because customer deposits are treated as liabilities. However, excessive leverage increases financial and systemic risk. This ratio helps assess the bank’s long-term financial stability.
Credit Operations & Management, Module: B, 96th Exam Q8(c)
