The RAK Bank and INDOVER Bank Performance, Research Paper Example

Return on Average Assets (ROAA)

The return on average assets essentially measures operational efficiency. This is the level of efficiency at which a given business uses the resources within its disposal. This is integral in helping determine the extent to which the business in question can expand. It is obtained using the following formula;

Based on the information provided in the table, R.A.K depicts higher operational efficiency than the INDOVER Bank. R.A.K. shows a relatively steady return on average assets. The bank experiences a positive ROAA, whereas the INDOVER bank depicts a negative ROAA, starts from a negative value between FY2011 and FY2012. This means that between FY2011 and FY2012, the bank was making losses relative to total average assets. This is a negative operational efficiency. This bank should not consider expansion.

Return on Average Equity (ROAE)

The return on average equity is essentially a measure of a company’s profitability within a given trading period, relative to the value of the shareholders’ equity. This ratio is important in giving an accurate picture of corporate profitability in cases where the shareholders’ equity has changed from the beginning of a trading period to the end of the trading period.

R.A.K. depicts a positive but depreciating ROAE between FY2011 and FY2013. The bank’s shareholders realize adequate profitability as it is just under the 30% minimum tax on profits. However, INDOVER bank has a negative but growing ROAE. This means that between FY2011 and FY2012, the bank’s shareholders realized losses per unit of equity held.

Net Interest Margin (NIM)

The net interest margin is a measure of performance that examines a financial institutions investment decisions against its debt situation. It is calculated as;

R.A.K. depicts a better net interest margin compared to the INDOVER bank. This generally means that R.A.K. makes better investments decisions relative to its debts. The INNDOVER bank depicts a poor net interest margin. The bank incurs a considerably large interest expense, relative to its debt position.

Cost to Income Ratio

The cost to income ratio is a measure of efficiency of a financial institution. It depicts the ability of a financial institution to minimize cost and maximize profits.

R.A.K. depicts a reasonable Cost income ratio. Its operating costs consume less than 44% of its operating income, depicting a good performance. The INDOVER bank depicts a considerably poor Cost Income Ratio. In FY2011 and FY2012, bank had its operating costs far surpass its operating income. The bank was experiencing loss during this period. In FY2013, its cost income ratio had dropped blow 100% to 90.24%. However, this CIR is still too large and means that most of its operating income is diverted to the operating costs incurred as a result of business processes.

Asset Quality Ratios

For most financial institutions, their asset quality is a key indicator of their performance. Financial institutions tend to expand their provision for most financial products such as insurance and deposits, the quality of their loans is the main element of its asset base. As such, this asset quality ratios are integral in determining the financial viability of a given financial institution.

Impairment Loss Allowance Ratio

This ratio compares the cumulated provisions for non-performing loans (NPLs) against the gross amount of loans within a financial institution’s loan portfolio. This essentially shows the amount of non-performing or impaired loan allowanceas a percentage of the gross amount on the loan portfolio. It is generally accepted that a financial institution with a higher percentage of impairment loss allowance ratio is much safer. This is because a higher ILAR indicates that the financial institution has adopted a conservative approach towards the anticipation of losses incurred as a result of default within its loan portfolio. However, it is vital to put into consideration that a higher impairment loss allowance ratio may depict a financial institution taking on risky assets.

The INDOVER bank depicts a much higher and growing impairment loss allowance ratio while R.A.K. depicts a much lower impairment loss ratio. This may be interpreted in two ways;

1. R.A.K. has a much riskier position on its loans should a considerable amount of their loans, i.e. above 2%, default in payments. This may cause a considerable upset in its financial position should such an situation be realized. The INDOVER bank has a much safer position on its loans should a considerable amount of their loans default. In order for the bank to realize an upset in its financial position, above 7% of its loans have to default in payment.
2. The INDOVER bank taking a more cautious approach in creating allowances for losses as a result of taking on risky assets in the form of loans. R.A.K. on the other hand has taken a less cautious approach towards creating allowances for losses on their loans as a result of undertaking less riskier assets.

Capital Ratios

Capital ratios are important in evaluating a financial institution’s financial strength through its equity capital, relative given number of indicatorswithin its financial statements. One of the most commonly used is the Tier 1 Capital Ratio.

Tier 1 Capital Ratio

This ratio compared a financial institution’s core equity relative to the total risk weighted assets. This essentially measures the financial strength of a financial institution based on the total value of its disclosed reserves and equity capital. However, non-cumulative and non-redeemablepreferred stock may be included in this analysis. The value of the risk-weighted assets of a firm includes only those assets that are weighted for credit risk and are held by the financial institution in question.

This ratio is used to rate or grade a financial institution’s capitalization as;

• Critically undercapitalized (? 2%)
• Significantly undercapitalized (< 3%)
• Undercapitalized (? 4%)
• Adequately capitalized (? 5%)
• or well capitalized (? 6% + no dividends or distributions)

Both banks depict a well-capitalized financial institution. R.A.K. depicts a growing tier 1 capital ratio, while the INDOVER bank depicts a diminishing Tier 1 Capital ratio. This means that R.A.K. grows in its financial strength while the INDOVER bank is experiencing diminishing growth in its financial strength.

Conclusion

Considering all the financial ratios employed in the performance analysis of both banks, R.A.K. bank depicts a better performance compared to the INDOVER bank. The bank appears to have a considerable financial strength and realizes more returns relative to its average assets and shareholders’ equity. The bank has adopted a riskier impaired allowance ratio as a result of taking on less riskier assets. This means that the bank rarely experiences default in payments of its loans. This creates a less risky asset base, providing the bank with room for growth of its insurance and loan business. The INDOVER bank depicts characteristics of a bank recovering from a period of considerable losses. The results of FY2011 and FY2012 depict very poor performance. However, the INDOVER bank appears to be gaining ground in FY2013. Even though it has an improving financial positions, it still records very poor performance.