Mariusz Chudzicki
Faculty of Management
Czestochowa University of Technology
Analysis of
commercial and cooperative banks operation efficiency
Abstract: One of the most significant tools that make difficult decisions in a
bank more easy is financial analysis. Financial analysis examines and assess
the operation efficiency of an enterprise and its property and financial
situation. The most important part of financial analysis of a bank are
financial ratios. Ratio analysis is a development of initial analysis of basic
financial documentation, that show the overall financial standing. The object
of ratio analysis are relations between particular elements of balance sheet
(in vertical and horizontal section) and income statement. The interesting
issue here is the comparison of financial standing of commercial and
cooperative banks. It is generally accepted that the latter are operating less
efficiently and generate much higher operating cost. The studies do not fully
confirm these assumptions.
Keywords: cost analysis, income statement, financial ratios
Introduction
Bank management is a continuous
process of making and implementing various decisions. Some of them relate to
current issues, others are of a strategic character and decide on the future
bank development.
There is a general assumption that
bank differs from other units because it offers financial services, manage
borrowed money and is a debtor – clients’ deposits are the main source of bank
activity financing.
One of the most important tools for
making right decisions in a bank is financial analysis. Financial analysis
investigate property and financial situation. Financial analysis comes handy
for a bank not only for proper interpretation of values from financial
statement, but most of all for better resources use, activity results
improvement, meeting market requirements and owners expectations. Financial
analysis should facilitate decision making leading to effective bank
development in the future.
In market economy financial analysis
is the part of economic analysis, that stands for the highest level of its
generalization. It covers all the vital issues related to the business unit
activity. It is affected by the synthetic character of ratios used in this
analysis. The issues evaluated with the financial analysis are: financial
outcome and the operation efficiency, profitability, costs and sales revenues,
property and financial situation of the enterprise. Synthetic grasp of those
issue allows to make a proper measurement and evaluation of results and
economic situation of the unit. Thanks to those advantages, and also to high
demand in the unit’s surroundings, this part of economic analysis – financial
analysis is commonly used in business activity. The entrepreneur, making
decisions, both related to current activity and to development projects, should
prepare and use analysis on future operation conditions. The reason is that
with every decision there come risk and uncertainty, as it is impossible to
determine what the factors affecting current decisions will be in the future.
According to this one should take under consideration all the conditions of the
enterprise operation and properly evaluate the risk of decisions made.
Financial analysis for a bank is
made for:
-
periodic
assessment of bank’s activity,
-
investigation
for causes of deviations from the plan or other basis, along with the
determination of causes and effects and the influence of external factors on
bank’s outcomes,
-
preparing
plans and projections,
-
comparison
with other banks and evaluation with the background of other banks
(competitiveness requires the outcomes comparison),
-
identification
of areas that need recovery activities, determination of threats and indication
of ways of their elimination[1].
Of special importance here is the
cost analysis of the bank and the cost development in comparison to other
financial units.
In its operation the bank is subject
to various caution regulations, with a purpose to limit risk and thus the
possibility of liquidity loss. Using the financial analysis methods one should
bear in mind, that those regulations strongly determine financial results of
banks, including of course operating costs.
Income statement of a bank
The income statement of a bank is
the comparison of incurred costs and drawn incomes in the reporting period,
usually from the beginning of the year until the date of the statement. Income
statement closes with a balance – profit when incomes exceed costs and loss
otherwise.
The income statement is the total of
incomes and costs in the reporting period. This way it differs from the balance
sheet that is a statement of assets and liabilities determined for a given
date, which is the balance sheet preparation date. The income statement shows
the total of costs and incomes of the whole period, as this is how outcome
accounts function in the accounting system: gather incurred costs and drawn
incomes in the form of one-side records, without balancing them.
The evaluation of bank activity
outcomes, shown also in the balance sheet, uses the preparation of income
statement, that is a main source of information on bank profitability and
provide information on bank costs level. The income statement shows the
particular stages of financial outcome creation, incomes, costs and outcomes of
individual areas of bank activity.
The incomes of the bank are mostly:
-
interest
on receivables and securities,
-
commissions
and fees received,
-
dividends
on shares owned by the bank,
-
positive
exchange differences,
-
incomes
from excessive or needless provisions termination.
The costs of the bank are:
-
interest
on bank deposit liabilities,
-
commissions
and fees paid,
-
negative
exchange differences,
-
special
funds deductions,
-
provisions
affecting costs,
-
bank
operating costs,
-
tangible
and intangible assets depreciation.
Incomes and costs classification is
made in two sections:
1.
Subject
– relates to clients of the bank operations:
-
financial
units,
-
non-financial
units,
-
public
sector units.
2.
Object
– relates to the type of drawn incomes and incurred costs:
-
interest,
-
commissions
and fees,
-
other.
The income statement analysis
includes[2]:
The analysis of data in analytic
income statement allows to determine general sources of the financial outcome
of a business unit.
In case of increase or decrease of
net profit the analysis investigates the individual elements of financial
outcome and the factors affecting them.
The purpose of vertical analysis of
income statement is the determination of main sources of costs and incomes
generation. Here we can examine e.g. what part of incomes are interest incomes
and what part of costs are interest costs and how they affect the financial
outcome.
The horizontal analysis of income
statement allows to evaluate which elements have greater and which smaller rate
of increase or decrease. An important part of this analysis is matching the
individual types of financial outcome. The reference point here can be
analogical previous period. The vertical analysis of income statement boils to
the assessment of costs and incomes generation sources.
Financial analysis of income
statement is of significant importance when trying to reveal the strengths and
weaknesses of bank activity. The thorough analysis of current financial
situation of a bank allows the managers to determine the position and condition
of the company in comparison with other banks and with the future plans[3].
Ratio analysis of bank costs
Ratio analysis is a method of
determination and evaluation of bank’s operation abilities and it is based on
standard measures of activity outcomes[4].
In other words when trying to find
if a bank has enough funds, or if it draws sufficient profits from own assets,
etc. it is necessary to use the set of proper ratios, which examine chosen
areas of bank activity[5].
Ratio analysis is a development of initial analysis of basic financial
documentation, that show the overall financial standing. It is one of the main
elements of financial analysis. The object of ratio analysis are relations
between particular elements of balance sheet (in vertical and horizontal
section) and income statement. It includes the construction of various ratios
using data from financial statements. Ratio analysis includes following stages[6]:
-
choice
of area of business unit activity to be evaluated,
-
selection
of economic ratios representative for selected area,
-
verification
of ratios and factors,
-
adjustment
of ratio or factor measurement method or determination of additional ratios and
factors, allowing to get the precise and unbiased picture of analyzed objects,
-
calculation
of ratio or/and factor based on verified measures and making of diagnosis and
formulation of decision.
The purposes of cost analysis in a
bank are[7]:
-
periodic
evaluation of bank activity, as a whole and in individual areas of activity,
and determination of areas that need recovery activities,
-
determination
of deviations of obtained outcomes from the plan and explanation of those
deviations,
-
assessment
of bank’s financial standing changes, and determination of internal and
external factors affecting them,
-
determination
of bank’s position in comparison to other banks,
-
assessment
of profitability of individual products,
-
preparation
of a basis for decision making,
-
preparation
of data base for strategic, tactical and operational plans,
-
identification
of bank’s strengths and weaknesses.
For the ratio analysis to be
valuable it is necessary to examine statements from at least three years. The
most important ratios in the financial analysis of a bank are interest margin
ratios, that can be described as a surplus of assets interest over liabilities
cost. This definition is best met by interest spread ratio, which is calculated
for interest assets and liabilities.
Interest incomes and liabilities
should refer to the same period. Those values come from income statement.
Net interest margin ratio is used
for evaluation of rate of return from income assets and the sensitivity of
profitability to market interest rates. This ratio is calculated by dividing
interest income by income assets (which are total assets reduced by cash and
receivables from other banks and also fixed assets and other assets).
The average interest cost of income
assets financing is calculated with the following formula.
If bank assets were fully financed
with own funds then of course profitability ratios for both those assets and
funds would be the same. In fact they are mostly financed with borrowed funds,
mostly deposits of clients, interbank deposits and securities of the bank. Of
lowest cost are deposits of clients, especially those with shortest maturity
(but they are also least stable) [8].
For using those funds the bank pays interest, but transforming them into loans,
deposits in financial institutions and securities it also obtain interest and
other incomes. If the total of interest and other costs related to using
borrowed funds is lower than the total of obtained incomes from using those
funds, then the profits positively affects the bank own funds profitability
ratio[9].
It is a financial leverage effect, which is especially common in bank activity.
This ratio measures the bank ability
to meet interest costs. In banking practice there are also following methods of
margin determination:
-
calculation
based on the market rates method – including calculation of effect of market conditions
for a transaction, and transformation of terms and also the concept of minimal
margin,
-
calculation
based on transfer rates – referring to internal money cost in the bank and its
flows through departments on central level and between central office and
branch offices,
-
calculation
of funds gathering cost[10].
Next group of ratios, which main
purpose is the analysis of bank activity costs are operating costs ratios,
measuring the level and distribution of total operation costs.
This ratio is called operating
ratio. It represents the scale of costs incurred for drawing one unit of
income. Operating ratio is calculated by dividing total interest and
non-interest costs (including lost loans costs) by gross operating profit (i.e.
total interest income plus non-interest income). The higher this ratio the
worse for the bank as the higher the part of income absorbed by costs the lower
the profit, and thus lower dividends and funds for reinvestment.
The difference between non-interest
costs and non-interest profit is sometimes called net load or net fixed cost.
This ratio determines net fixed load
as a percent of total income assets.
This extra benefit, that the bank
receives through employment and efficient use of borrowed funds is called
financial leverage. The supplementary ratio is costs level ratio, indicating
what portion of bank incomes was spent to cover the costs. This ratio is
calculated using data from income statement.
The third group of efficiency ratios
are financial outcome load ratios. They refer mainly to provisions and
operating costs (including personnel costs) load on bank activity outcomes[11].
Financial outcome provisions load
ratio is as following:
If this ratio is positive it means
that the bank makes more provisions than terminates them. If the ratio is
negative it means that the provisions did not loaded bank outcome but allowed
to increase it.
Financial outcome load with
operating costs indicates what portion of bank operation outcome was spent to
cover operating costs. The most significant of those costs are personnel costs
(wages, deductions for social insurance and other considerations for
personnel).
The last group of selected ratios
are personnel efficiency ratios[12].
They confront bank operation outcomes (represented by assets value or net
financial outcome) with the number of personnel in the bank.
Those ratios show on average what
assets value and outcome was produced by one unit of personnel. Due to the
volume of individual transactions their values differ when we analyze retail
bank or corporate bank. The results of those ratios are usually lower for
retail banks, which have bigger personnel. In order to limit personnel costs
banks introduce commission system that is about to discourage clients to use
branch office and use electronic transactions instead. As those transactions
are cheaper for a bank, the difference in those ratios between retail and
corporate banks can disappear in the future.
Chosen financial ratios for cooperative and commercial banks
The bank supervision includes some
modifications of presented ratios or uses other ratios, which are periodically
investigated. But apart from solvency ratio, that has to be strictly obeyed by
all banks[13], other ratios are of
rather information character – they are used mainly to evaluate the situation
of a banking sector as a whole. The interesting issue here is the comparison of
financial standing of commercial and cooperative banks. It is generally
accepted that the latter are operating less efficiently and generate much
higher operating cost. The studies do not fully confirm these assumptions.
Table 1. Chosen financial
ratios for commercial and cooperative banks in years 2004-2005
|
ratio |
commercial
banks |
cooperative
banks |
||
|
2004 |
2005 |
2004 |
2005 |
|
|
costs levela |
90,8 |
88,4 |
83,1 |
82,6 |
|
gross profitability ratiob |
10,1 |
13,1 |
20,3 |
21,1 |
|
net profitability ratioc |
9,2 |
10,9 |
16,6 |
17,1 |
a
total costs / total incomes.
b
gross financial outcome / total costs.
c
net financial outcome / total costs.
Source: Sytuacja
finansowa banków w 2005r., NBP, May 2006.
While the part of operating costs in
financial outcome is much higher in cooperative banks (Table 2), the total
costs level in relation to incomes is higher in commercial banks (Table 1). It
confirms the relatively low cost of capital in cooperative banks, what is
further confirmed by interest margin ratio.
The
situation is not clear for profitability ratios, but generally commercial banks
improve the efficiency in all analyzed areas, while cooperative banks do not.
It can especially be seen with decreasing ROA and ROE ratios.
Table 2. Chosen financial
ratios for commercial and cooperative banks in years 2004-2005
|
ratio |
commercial
banks |
cooperative
banks |
||
|
2004 |
2005 |
2004 |
2005 |
|
|
interest margina |
3,1 |
3,1 |
5,9 |
5,6 |
|
operating costs ratiob |
64,6 |
60,8 |
71,6 |
72,0 |
|
ROAc |
1,4 |
1,7 |
1,8 |
1,6 |
|
ROEd |
17,1 |
21,0 |
18,3 |
17,4 |
a interest outcome / average assets
less matured interest on receivables at risk.
b operating costs (operation +
depreciation) / bank operation outcome adjusted with other incomes and
operating costs outcome.
c net financial outcome /
average assets less matured interest on receivables at risk.
d net financial outcome /
average equity.
Source: Sytuacja
finansowa banków w 2005r., NBP, May 2006.
The great spread between ROA and
ROE, unusual for non-financial units, is typical for banks, as they use the
large amount of borrowed funds to finance their assets. This is a positive
effect of financial leverage. To keep this leverage on high level in the future
some banks do not increase equity on purpose, for example not retaining profits
and paying high dividends.
Table 3. Personnel
efficiency ratios in commercial and cooperative banks
|
ratio |
commercial banks |
cooperative banks |
||
|
2004 |
2005 |
2004 |
2005 |
|
|
number of personnel
(full posts) |
122 005 |
124 689 |
27 600 |
28 283 |
|
banking sector assets
value (million PLN) |
509 756 |
553 108 |
28 717 |
33 914 |
|
banking sector
financial outcome (million PLN) |
6 663 |
8 695 |
478 |
509 |
|
assets / number of
posts |
4 178 153 |
4 435 899 |
1 040 464 |
1 199 088 |
|
financial outcome /
number of posts |
54 613 |
69 734 |
17 301 |
17 986 |
Source: Sytuacja
finansowa banków w 2005r., NBP, May 2006.
Personnel efficiency ratios
definitely favors commercial banks, according both to assets per post and drawn
profits. This difference seems impossible to reduce, knowing the character of
those banks activity. As cooperative banks usually provide services for individuals,
small enterprises and farmers, they cannot gain large individual profits and
thus the higher personnel efficiency. Those ratios also show that wages in
commercial banks currently are and will remain higher than in cooperative
banks.
Conclusion
Financial analysis is used in for
various purposes depending on who ordered it. Apart from traditional use for
decision making process by bank managers it is also of great importance for
bank supervision, investors and potential clients. Ratios for banking sector
presented in this paper indicate the gradual improvement of this sector
situation, which is achieved in case of commercial banks mainly by reducing
operating costs. Cooperative banks cannot compete with commercial banks in
terms of activity efficiency, but when it comes to funds profitability they
achieve very good results. On conclusion the perspectives for banking sector
are positive, both in the area of financial outcomes and of level of clients
service increase.
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