ALTERNATIVE MODELS OF BANK PERFORMANCE.ppt

ALTERNATIVE MODELS OF BANK PERFORMANCE Chapter 4 Traditional bank performance analysis carries three basic flaws It ignores the wide diversity in strategies pursued by different institutions A bank’s total assets no longer serve as a meaningful yardstick when banks engage in off-balance sheet activities The analysis provides no directinformation concerning how or which of the bank’s activities contribute to the creation of shareholder value Wide diversity in strategies pursued by different institutions When UBPRs were introduced, most banks did similar things, which were reflected in their balance sheet They accepted deposits and made loans, and many interest rates were regulated The primary differentiation of performance was balance sheet composition Today, banks may pursue sharply different strategies Bank’s total assets no longer serve as a meaningful yardstick when banks engage in off-balance sheet activities Consider the situation where two banks report the same asset size, but one also has an extensive mortgage-servicing operation that generates servicing income If the bank with mortgage-servicing makes a profit on this activity, it will report a higher ROA, ceteris paribus, due to the higher noninterest income for mortgage-servicing fees The analysis provides no direct information concerning how or which of the bank’s activities contribute to the creation of shareholder value It similarly ignores other performance benchmarks that customer-focused managers must consider to identify the best strategies going forward Although ROA might be a biased indicator of performance, return on equity (ROE) doesn’t suffer from the same weaknesses. When considering the entire bank, stockholders’ equity must support all activities, whether on- or off-balance sheet. Thus, a comparison of net income to equity captures the returns to owners’ contributions. The appropriate peer group…as long as banks have a similar strategic focus and offer similar products and