One distinctive characteristic of banks is their asset composition
ￂﾠ Generally, non-financial companies￢ﾀﾙ assets are predominantly tangible assets, such as plants, properties and equipment.ￂﾠ While bank assets are predominantly financial assets such as loans and securities and their liabilities are primarily deposits. Banks are also heavily regulated by authorities as such, capital, minimum liquidity, and the riskiness of assets must meet authorities￢ﾀﾙ requirements. Hence, certain conventional financial ratios such as Gross Profit Margin, Inventory Turnover, Current Ratio and D/E etc are not relevant. The most common rating approach for banks is ￢ﾀﾜCAMELS￢ﾀﾝ, an acronym of six components as follows: Capital adequacy Capital adequacy for banks is described in terms of the proportion of the bank￢ﾀﾙs assets funded with capital. For purposes of determining capital adequacy, a bank￢ﾀﾙs assets are adjusted based on their risk, with riskier assets requiring a higher weightage. Asset quality Asset quality pertains to the amount of existing and potential credit risk associated with a bank￢ﾀﾙs assets and focuses primarily on financial assets. Management capabilities Management capability is the ability to identify and control risk, including credit risk, market risk, operating risk, legal risk, and other risks. Earnings sufficiency Earning sufficiency means banks should ideally generate an amount of earnings to provide an adequate return on capital to their capital providers and specifically to reward their stockholders through capital appreciation and/or distribution of earnings. Liquidity position Adequate liquidity is essential for any type of entity. Banks￢ﾀﾙ systemic importance increases the importance of adequate liquidity. If a non-bank entity￢ﾀﾙs insufficient liquidity prevents it from paying a current liability, the impact would primarily affect the entity￢ﾀﾙs own supply chain. Sensitivity to market risk Banks￢ﾀﾙ operational sensitivity to interest rates, exchange rates, equity prices, or commodity prices are key to its financial strength. Table 1 shows some selected ratios that fall within CAMELS rating methodology, amongst other: Category ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Financial Ratio Capital Adequacy ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Common Equity Tier (CET) 1 Capital Ratio; ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Total Capital Ratio Asset Quality ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Gross Impaired Loan Ratio (GIL) Management Capabilities ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Cost to Income Ratio; ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Efficiency Ratio Earnings Sufficiency ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Return On Equity (ROE) Liquidity Positions ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Liquidity Coverage Ratio (LCR); ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Net Stable Funding Ratio (NSFR) Sensitivity to Market Risk ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Value at Risk (VaR) Non-CAMELS Liquidity ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Loan to Deposit Ratio (LDR) Valuation ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Price to Book (PB) Table 1.ￂﾠ Selected Financial Ratios for CAMELS and non-CAMELS rating methodology The ratios for CAME are readily available in Annual Reports, but the "Liquidity Positions" and "Sensitivity to Market Risk" are not commonly reported in banks￢ﾀﾙ Annual Reports.ￂﾠ For instance, BASEL III (Read more here) requires banks to report LCR and NSFR on monthly basis but they are not disclosed in the Annual Report.ￂﾠ Also, VaR is not published in an annual report as well.ￂﾠ Thus, for retail investors to evaluate the ratios of bank stocks, both ￢ﾀﾜLiquidity Positions￢ﾀﾝ and ￢ﾀﾜSensitivity to Market Risk￢ﾀﾝ categories are replaced with liquidity and valuation ratio such as LDR and PB. Table 2 and 3 are some real-world examples of the above ratios based on eight commercial banks listed on Bursa Malaysia.ￂﾠ Readers are reminded not to rely solely on the brief financial ratio ranking for investment decision. ￂﾠ ￂﾠ ￂﾠTable 2. Selected Financial Ratios for eight commercial banks listed on Bursa Malaysia Source: Dynaquest Sdn. Bhd. STOCKBASE platform, except *.ￂﾠ See ￢ﾀﾜNotes￢ﾀﾝ at the end of this article for Copyrights details. * Calculated based on latest Annual Report Table 3.ￂﾠ Ranking based on Financial Ratios in Table 2 Reference: Analysis of Financial Institutions by Jack T. Ciesielski, CPA, CFA, and Elaine Henry, PhD, CFA Disclaimer:ￂﾠ The above analysis does not imply any buy or sell recommendation.ￂﾠ The author disclaims all liabilities arising from any use of the information contained in this article. Disclosure: The author may have interest in the stocks of the companies in this article. Notes:ￂﾠ The data are the property of Dynaquest Sdn. Bhd.ￂﾠ It is subject to Intellectual Property Rights and T
ￂﾠ Generally, non-financial companies￢ﾀﾙ assets are predominantly tangible assets, such as plants, properties and equipment.ￂﾠ While bank assets are predominantly financial assets such as loans and securities and their liabilities are primarily deposits. Banks are also heavily regulated by authorities as such, capital, minimum liquidity, and the riskiness of assets must meet authorities￢ﾀﾙ requirements. Hence, certain conventional financial ratios such as Gross Profit Margin, Inventory Turnover, Current Ratio and D/E etc are not relevant. The most common rating approach for banks is ￢ﾀﾜCAMELS￢ﾀﾝ, an acronym of six components as follows: Capital adequacy Capital adequacy for banks is described in terms of the proportion of the bank￢ﾀﾙs assets funded with capital. For purposes of determining capital adequacy, a bank￢ﾀﾙs assets are adjusted based on their risk, with riskier assets requiring a higher weightage. Asset quality Asset quality pertains to the amount of existing and potential credit risk associated with a bank￢ﾀﾙs assets and focuses primarily on financial assets. Management capabilities Management capability is the ability to identify and control risk, including credit risk, market risk, operating risk, legal risk, and other risks. Earnings sufficiency Earning sufficiency means banks should ideally generate an amount of earnings to provide an adequate return on capital to their capital providers and specifically to reward their stockholders through capital appreciation and/or distribution of earnings. Liquidity position Adequate liquidity is essential for any type of entity. Banks￢ﾀﾙ systemic importance increases the importance of adequate liquidity. If a non-bank entity￢ﾀﾙs insufficient liquidity prevents it from paying a current liability, the impact would primarily affect the entity￢ﾀﾙs own supply chain. Sensitivity to market risk Banks￢ﾀﾙ operational sensitivity to interest rates, exchange rates, equity prices, or commodity prices are key to its financial strength. Table 1 shows some selected ratios that fall within CAMELS rating methodology, amongst other: Category ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Financial Ratio Capital Adequacy ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Common Equity Tier (CET) 1 Capital Ratio; ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Total Capital Ratio Asset Quality ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Gross Impaired Loan Ratio (GIL) Management Capabilities ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Cost to Income Ratio; ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Efficiency Ratio Earnings Sufficiency ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Return On Equity (ROE) Liquidity Positions ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Liquidity Coverage Ratio (LCR); ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Net Stable Funding Ratio (NSFR) Sensitivity to Market Risk ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Value at Risk (VaR) Non-CAMELS Liquidity ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Loan to Deposit Ratio (LDR) Valuation ￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠￂﾠ Price to Book (PB) Table 1.ￂﾠ Selected Financial Ratios for CAMELS and non-CAMELS rating methodology The ratios for CAME are readily available in Annual Reports, but the "Liquidity Positions" and "Sensitivity to Market Risk" are not commonly reported in banks￢ﾀﾙ Annual Reports.ￂﾠ For instance, BASEL III (Read more here) requires banks to report LCR and NSFR on monthly basis but they are not disclosed in the Annual Report.ￂﾠ Also, VaR is not published in an annual report as well.ￂﾠ Thus, for retail investors to evaluate the ratios of bank stocks, both ￢ﾀﾜLiquidity Positions￢ﾀﾝ and ￢ﾀﾜSensitivity to Market Risk￢ﾀﾝ categories are replaced with liquidity and valuation ratio such as LDR and PB. Table 2 and 3 are some real-world examples of the above ratios based on eight commercial banks listed on Bursa Malaysia.ￂﾠ Readers are reminded not to rely solely on the brief financial ratio ranking for investment decision. ￂﾠ ￂﾠ ￂﾠTable 2. Selected Financial Ratios for eight commercial banks listed on Bursa Malaysia Source: Dynaquest Sdn. Bhd. STOCKBASE platform, except *.ￂﾠ See ￢ﾀﾜNotes￢ﾀﾝ at the end of this article for Copyrights details. * Calculated based on latest Annual Report Table 3.ￂﾠ Ranking based on Financial Ratios in Table 2 Reference: Analysis of Financial Institutions by Jack T. Ciesielski, CPA, CFA, and Elaine Henry, PhD, CFA Disclaimer:ￂﾠ The above analysis does not imply any buy or sell recommendation.ￂﾠ The author disclaims all liabilities arising from any use of the information contained in this article. Disclosure: The author may have interest in the stocks of the companies in this article. Notes:ￂﾠ The data are the property of Dynaquest Sdn. Bhd.ￂﾠ It is subject to Intellectual Property Rights and T
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