## Assessing the level of commercial bank profit

Category: Concept of the Bank and the Banking System

The main methods of assessing level of profit a commercial bank can be identified:

Structural analysis of the sources of profit;

analysis of financial ratios;

factor analysis.

The purpose of structural analysis is to identify the main source of income and assessment of it in terms of stability, maintaining in the future and growth prospects.

One of the main methods of assessing the level of profitability of the commercial bank is the analysis of financial ratios. This analysis is as follows:

— Comparing the actual calculated value of financial ratios with its regulations (criteria) level;

— Comparison of the coefficients of the bank with coefficients of competing banks belonging to this group;

— Assessment of the dynamics of the coefficients;

— Factor analysis of the dynamics of the coefficient.

Coefficient system profitability includes the following:

— The ratio of profits and assets;

— The ratio of profit before tax and assets;

— The ratio of profit and equity;

— Profit per employee.

Method of calculating these indicators depends on the adopted country reporting and recording system. In this regard, consider the options for calculating these indicators, as well as their economic content.

Profit to total assets is the primary factor that allows to make a first quantitative assessment of profitability of the bank. With the current system of accounting and reporting methods for calculating this ratio may be as follows:

K = (balance sheet profit for the period) / (average balance of total asset balance in the period) (5,1)

K = (balance sheet profit for the period — Unstable income) / (average balance of total asset balance in the period) (5,2)

The difference between first and second factor lies in the fact that profits are cleared from unstable sources. This is of fundamental importance when further evaluated the dynamics of the coefficient. The rating may be high, if the growth factors of profitability is provided by unstable sources.

When the foreign accounting standards, as already noted, is determined by net income. In this case, the calculation of similar factors is as follows:

K = (Net profit for the period) / (average balance of total asset balance in the period) (5,3)

K = (Net profit for the period — Unstable income) / (average balance of total asset balance in the period) (5,4)

Due to differences between the carrying amounts and net profit ratios 5.1 and 5.3, and 5.2 and 5.4 are not comparable. However, we can compare the ratios 5.3 and 5.4, as well as the coefficients of 5.1 and 5.2, to make real conclusions on the basis of changes in the values of the coefficients.

When calculating the coefficients based on net income can use their standard values recommended by the experts of the World Bank as a result of generalization of banking experience. In particular, the standard level of the coefficient of 5.3 should range from 1.15 to 0.35%, 5.4 — 1,0 to 0,6%.

Profit before tax to total assets — a ratio that are mapped by a factor of income / assets to assess the management of profit.

The calculation of the coefficient:

a) the accounting system:

K = (balance sheet profit for the period + Taxes paid during the period and attributable to the cost of banking operations) / (average balance of the total asset balance for the period) (5,5)

b) the accounting system by world standards:

K = (Net profit for the period + All taxes paid during the period) / (average balance of the total balance for the period) (5,6)

The greater the discrepancy between the coefficients of income / assets and profit before tax / total assets (ie, 5.1 and 5.5, 5.2 and 5.6 ratios), the lower ceteris paribus profit management.

Profit to equity ratio. Equity capital — the most stable part of the resources of a commercial bank. Therefore, the stability or growth in earnings per ruble equity in prior periods guarantees a certain extent, maintenance of a level of profitability of the bank in the future. Finally, this ratio is interested in the founders, shareholders or stockholders, as it shows the effectiveness of their investments.

Methodology of calculation of the profitability of equity capital in:

a) the accounting system:

K = (balance sheet profit for the period) / (average size of the equity in the period) (5,7)

K = (balance sheet profit for the period) / (average size of charter capital in the period) (5 8)

K = (balance sheet profit for the period — Fragile items of income in the period) / (average size of charter capital) (5 9)

K = (Book profit + taxes attributable to the cost) / (average size of charter capital) (5,10)

b) the accounting system by world standards:

K = (Net profit for the period) / (average size of equity capital in the period) (5,11)

K = (Net profit for the period) / (average size of the equity in the period) (5.12)

K = (Net profit for the period — Fragile items of income in the period) / (average size of the equity in the period) (5,13)

K = (Net profit for the period + All taxes paid (income before taxes)) / (Average Equity) (5,14)

Regulatory level for the coefficient of 5.11 between 10 and 20%, to 5.14 — 15%.

Profit per employee — a ratio that allows us to evaluate how consistent profit management and staff.

The method of calculating the coefficient of:

K = (book profit) / (average number of bank employees in the period) (5,15)

a) the accounting system:

K = (Net profit for the period) / (average number of bank employees in the period) (5.16)

b) the accounting system by world standards:

Fundamental factors in the profitability indicator is income / assets. The actual value of this index is not the sole criterion for assessing the effectiveness (profitability) of the bank. This is due, firstly, the fact that high income is conjugate, usually with a big lawsuit. It is therefore very important to simultaneously take into account the P degree of protection against the risk of the bank. Secondly, the fundamental importance of the economic phenomena that are rooted in factors determining the dynamics of the title of the coefficient of profitability.

To clarify the first position to consider the assessment of the profitability of commercial banks in the U.S. system Camels.

The basis for assessing the level of bank profitability in the system Camels are quantitative and qualitative parameters.

To quantify the profitability of the banks of the many indicators of the level of their revenues and profits elected effectiveness ratio of assets:

K = (Net profit) / (average total assets) (5.17)

Regulatory level of this factor is set by groups of banks, based on the separation of which is the amount of assets. All banks are divided into five groups:

I — assets less than $ 100 million

II — 100 to $ 300 million

III — 300 to 1000 million dollars

IV — 1 to $ 5 billion V — more than $ 5 billion

For each of these groups set the average efficiency ratio of assets based on the actual level for 3 years. To identify the most and least profitable banks of this group used the following approach. It is based on the decreasing number of actual average values of the named factor for 3 years on the banks of the group.

The ratio of profitability higher rating (5.1) corresponds to the average value of the highest coefficients of the beginning of the series, whose number amounts to 15% of the total number of coefficients of this group of banks. Average of the following factors of 50% is the regulatory level for a satisfactory level (2) 20% — a mediocre level (3) and 15% — maximum level (4). With statement given rating 5 — unsatisfactory.

In other words, levels, who share the resulting list of average values of the efficiency of asset utilization by 15% the highest level, 50% satisfactory, 20% of the investigative level and 15% limit (lower) level are used to establish the baseline proportions.

Using actual values of the initial three years reduces the impact on standards of bank profitability short term impact of recession or growth in revenue associated with the dynamics of the economy. Criteria of profitability have become more stable and less susceptible to cyclical fluctuations.

The representative of the supervisor compares the value of the asset utilization with a normative level, to give a preliminary assessment of the bank’s rating for its level of profitability. For the final assessment takes into account the quality and structure of income, degree of protection against the risk of the bank. In particular, depending on how this value profit of the bank due to insufficient reserves to cover loan losses, is exposed to income from securities, delays in the payment of taxes, ordinary income, quantitative assessment of the profitability of the bank may increase or decrease. In accordance with this there is the following scale to rate the bank’s level of profitability.

Thus, the method of assessing the level of profitability of the system allows the camel to make the following basic conclusions:

the bank can not get a high ranking based only on high quantitative values of profitability, it is not protected from the risk of capital adequacy and sufficiency of reserve for loan losses;

when assessing the level of profitability, along with the quantitative parameters are taken into account the stability of revenue sources;

important methods of assessing the level of profitability is to analyze the dynamics of the corresponding coefficient.

Factor analysis of bank profits can be made in different ways.

**Rating 1 — the highest (strongest):**

Coefficient of effective use of assets complies with the top 15% of the banks, the bank has sufficient reserves to cover losses on loans, profits are not dependent on delays in the payment of taxes, income from securities transactions and extraordinary income.

**Rating 2 — Satisfactory:**

Coefficient above the average for this group of banks, but lower than Standard 1, revenues are static and are sufficient for the establishment of a reserve intended to cover losses on loans, lower rate was of only short duration.

**Rating 3 — mediocre:**

Coefficient below the average for the group of banks, but above the norm for the worst 15% of the banks was negative trend coefficient, a high level of interest rates on dividends and insufficient reserves to cover loan losses.

**Rating 4 — Marginal:**

Profit is, but profit margins below the norm for the worst 15% of banks; unpredictable fluctuations in revenues, a negative trend coefficient, lack of provision for losses on loans, lack of profit growth for the equity.

**Rating 5 — unsatisfactory:**

Net loss or a profit, but its presence is related to covering losses due to tax benefits, income from securities and extraordinary income.

First, the basic factors of profitability of the bank derived from the contents of the numerator and denominator of the profitability ratio (profit to assets). Substitution method detected the main factor to determine the dynamics of the coefficient, — to change the absolute value of profits and assets. Depending on this, then identifies the main factors increasing or decreasing the size of the profits or assets.

The main factors of the absolute size of the bank’s profits are:

ratio of growth (decline) of income and expenditure of the bank;

average profitability of individual active operations of the bank;

the share of assets, income-generating assets (share of working assets);

movement of interest rates on active and passive operations of the bank;

* Structure of assets, income;

* Structure of loan portfolio;

* The share of risky active operations of the bank’s assets;

* The profitability of certain types of active operations.

Secondly, the technique of factor analysis the level of bank profits is the expansion coefficients of the profitability of the factors.

As an example, consider two factors

1) income / assets of the bank = bank’s gross income / total assets = profit / gross income of the bank

Comparison of the three coefficients for the year shows that the decline in overall profit margins due mostly to reduced yield of the active operations of the bank. This could be due to changes in interest rates and the level of commission, as well as changes in the share of assets, income (share of working assets). The latter is characterized by the efficiency ratio:

Keff = AD / A

where Keff — the coefficient of efficiency; Hell — the average balance in the period, assets, income, and A — the average balance in the period following the asset balance.

2) (Net income [= ROE — Return on Equity (net income)]) / (equity) = (Net income [= ROA — Return on Assets (net return on assets)]) / (Assets) = Assets / Equity capital

In turn, the ratio of net income to assets is also decomposed into two factors, as was shown in the first example. As a result, the equation becomes:

Net profit / equity = (net profit / gross revenue) x (gross income / assets) x (assets / equity) = x revenue margin return on assets ratio leverazha x (multiplier of capital)

Ratio of net income and shareholders’ equity presented in the form of three factors, it is known in the world as a formula Ducon. It shows the main areas of growth investors, commercial banks profitability and ensure the continuing profitability of the bank. Growth factors, return on assets were identified in the first example. Growth of the revenue margin depends on the level of interest rates and commissions, the ratio of the rate of growth of income and expenditure of the bank, the cost of resources, etc.

Improvement factor leverazha depends on the growth of attracted funds of the bank. The most profitable expansion of banks’ deposit base, which provides relatively low cost of resources and less dependence on bank interest rate fluctuations in the money market.