1. Banking and Financial Services
By the Numbers
Banking and Financial Services

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3. Balance sheet analysis
Types of Analysis
Balance sheet analysis
Ratio analysis
CAMELS model
Risk analysis
A bank’s performance must be reviewed and analyzed to determine how profitable and effective it is. There are four common ways to accomplish this task: balance sheet analysis, ratio analysis, the CAMELS model, and risk analysis.
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4. Balance Sheet Vocabulary
Balance Sheet – a financial document that shows a company’s assets, liabilities, and stockholder’s equity
Assets – things that are owned by the bank
Liabilities – debts that are owed by the bank
Terminology is important to understanding the parts of a balance sheet. The Balance Sheet itself shows a company’s assets, liabilities, and stockholder’s equity. Assets are what a business owns. Liabilities are how much debt a business has. Stockholder’s Equity is the company’s net worth or capital, and is the difference between the assets and the liabilities.
Stockholder’s Equity – the difference between assets and liabilities, also known as capital
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5. Ratio Analysis - NIM
Ratio Analysis – a method of making comparisons to make numbers meaningful
Net Interest Margin (NIM)– measures how much interest is being earned on assets
Net interest income – while net income is the difference between income and expenses, net interest income is the difference between interest earned and interest paid
(NIM) = (Interest Income – Interest Expense)/Total Assets X 100
* * The higher the percent, the better, preferably over 5%. As an example, this means that a bank is paying less interest on deposits and is earning more interest from loans.
Ratio analysis is one of the ways to assess a bank’s performance. Net interest margin is important in measuring how much interest is being earned on its assets.
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6. Ratio Analysis - ROA
Return on Assets (ROA)– measures how much profit a bank earns for each dollar value of its assets
ROA = Net Income/Total Assets X 100
This ratio shows how well a bank’s
assets are generating profits.
* * The higher the percent, the better,
preferably more than 1%.
Net Income =
Income - Expenses
Return on assets is an important ratio because it shows how well a bank’s assets are generating profits, which is income less expenses. This shows why keeping expenses as low as possible is positive for this ratio.
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7. Ratio Analysis - ROE
Return on Equity (ROE) – measures how well a bank can make a return for its investors, or stockholders
Stockholders Equity = Assets – Liabilities
ROE = (Net Income/Stockholders Equity) X 100
* * The higher the percent, the better, preferably more than 10%
Net Income =
Income - Expenses
A company wants to do well so more individuals and businesses will want to invest in its stock. A company’s return on equity measures how well a bank can make a return for its investors, or stockholders.
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8. Spread Spread is actually not a ratio
Spread – the difference between what the bank receives from customers in loan interest and what it pays out in interest on its customers’ deposits
* * The higher the spread percentage, the better, preferably greater than 5%.
The largest income for a bank is interest from loans, and the largest expense is interest paid on deposits.
The spread is not actually a ratio but it is a major source of income for banks. It is the difference between what the bank receives from customers in loan interest and what it pays out in interest on its customers’ deposits.
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9. CAMELS Model CAMELS Model – an international bank rating system
originally developed in 1979 in the U. S. and
called the Uniform Financial Institutions Rating System
renamed CAMELS by the Federal Reserve and Office of the Comptroller of the Currency in 1995.
Each of six factors is rated on a scale of 1to 5, with 1 being the best rating
Only available to management, not to the public
The CAMELS model is another way to assess a bank’s performance. It is an international bank rating system that was actually developed in CAMELS is an acronym where each letter is a factor which is rated on a scale of 1 to 5. This rating is not made available to the public, only to management.
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10. CAMELS Acronym C
Capital Adequacy A
Asset Quality M
Management E
Earnings L
Liquidity S
Sensitivity to Market Risk
The CAMELS acronym stands for: capital adequacy, asset quality, management, earnings, liquidity, and sensitivity to market risk.
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11. C - Capital Adequacy
Having enough capital to help cover losses, if any
Capital ratio – a measure of the amount of capital a financial institution has compared to its assets
Capital ratio = (total capital/total assets) X 100
Good ratio is greater than 10% and bank receives a better rating
Less than 5% can mean bank is undercapitalized, meaning not enough capital to handle any losses
Capital adequacy refers to a bank having enough capital to cover any shortfalls or losses. If this ratio is too low, a bank can be undercapitalized, or said to have insufficient capital in the event there were any losses.
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12. A - Asset Quality
Bank assets consist of the loans they make and the investments they make.
If loans are not repaid, the bank cannot make the income it expects. If investments are too risky, the returns may not be what is expected either.
Asset quality – the risks associated with the bank’s assets
Good asset quality shows that a bank can continue making income with its loans and investments.
A large part of the bank’s assets are the loans it makes to customers. High quality refers to performing loans while low quality means that loans could be in default. This can negatively affect a bank’s income.
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13. M - Management Difficult to measure
Holding a financial institution’s Board of Directors more accountable
Must be able to take corrective action in possible crisis situations
The management factor is probably the most difficult to quantify, and thus assign a rating value to. One way to improve this rating is for a bank to hold its Board of Directors more accountable. Management must be able to take corrective action to hopefully prevent crisis situations.
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14. E - Earnings Good rating created with positive earnings
A positive trend in earnings also creates a good rating.
Earnings that have consistent projections for the future are positive, such as from loans, fees, and investments.
Having positive earnings is definitely positive for a business. However, having an ongoing trend of positive earnings over time can generate an even higher rating. This also makes projecting future revenues easier to do for a business.
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15. L - Liquidity Liquidity – having enough cash on hand
Reserve requirements exist to ensure there is a minimum percentage of deposits on hand for customer withdrawals.
New customer deposits are harder to predict than long-term customer deposits.
Does the bank have assets on hand that can quickly be converted to cash or will it have to borrow from the Federal Reserve?
Liquidity is important for any business because it means that, in case of an emergency, a business has enough cash on hand or assets that can easily be converted to cash if necessary. The bank’s deposits are a major liquid asset. For a bank, the behaviors of long-term customers provide a way for the bank to predict deposits which are readily available cash. It is more difficult for a bank to predict deposits for new customers.
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16. S – Sensitivity to Market Risk
Market risk – the possibility of a change in an asset’s value depending upon market conditions
Market risk, as well as a bank’s profitability, can be affected by the state of the economy.
The less risk, the better for a bank or other financial institution.
Sensitivity to market risk refers to a bank’s ability to adjust for changes in the economy that can affect the value of its assets, including changes in interest rates as well as foreign exchange rates.
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17. Risk Analysis Types of Risk
Risk – the probability of an event occurring which may include the likelihood of profit or loss due to the level of the risk
Credit
Liquidity
Interest-Rate
Types of Risk
Risk analysis is the final method of assessing a bank’s performance. Types of risk for banks include interest-rate risk, liquidity risk, and credit risk.
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18. Risk Comparison Interest-Rate Risk Liquidity Risk Credit Risk
Risk of changes in interest rates reducing income for banks
Risk that a bank cannot raise enough cash when needed
Risk that a borrower may not be able to repay a loan
If interest rates decline on deposits, can lead to less revenue
Federal Reserve requires minimum 10% cash on hand
This risk can also be affected by the economy.
Better forecasting or planning for interest-rate fluctuation
Invest in more liquid securities in case they need to be sold for cash
Better credit analysis of each customer
An example of interest-rate risk is if rates were to decline on deposits, revenue would decrease for the bank. Liquidity risk refers to not having enough cash on hand, although the Federal Reserve requires a minimum of 10%. Credit risk refers to the possibility of borrowers who may not be able to repay their loans, which also decreases a banks revenue.
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19. Independent Practice Assignments
Ratio Analysis Assignment #1 – Have students go online and locate financial statements for a bank of the student’s choosing. Using the appropriate financial statements, students will calculate the ratios presented in this lesson. Then they will summarize their results explaining which ratios are favorable and which ones are not. They should create a chart of their results. They may do this manually or on the computer depending on whether or not there is lab access.
Spread Calculation Report Assignment #2 – To help students understand the concept of a spread, students will research a bank web site and determine what the average interest rate charged on a home loan is and then the average rate on savings accounts. Then they will take the difference between the rates. This is the spread. In a one-page report they will explain this process, the interest-rate calculations for the mortgage and savings rates, and the difference. Then they will summarize the importance of spread to the income or profit of a bank.
CAMELS Comic Strip Assignment #3 – Students will create a six-eight panel comic strip demonstrating their knowledge of the CAMELS rating system. They will include speaking bubbles that show discussions into what the acronym stands for, what countries may use the rating system, what the ratings mean, and any other information they can include in their comic strip.
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