Indicators for Measuring the Business Performance of Commercial Banks

A particular business, in a more specific perspective, has many different concepts and perspectives on the effectiveness of banking operations.

The first point of view, Yale University Professor of Economics and Finance Peter S. Rose (2004) said: in essence, commercial banks can also be considered as business corporations and operate with the goal of maximizing profits with an acceptable level of risk. However, achieving high business efficiency is the goal that banks are interested in because it determines the existence and development of the bank, and can help the bank expand its scale.

The second view, the European Central Bank (ECB) (2010) argues that: the efficiency of banking business is the ability to generate sustainable profits. The profits earned are first used to cover unexpected losses and strengthen the capital position, and then improve future profits through investment from retained earnings.

Third point of view, Associate Professor Dr. Nguyen Khac Minh (2006) believes that: operational efficiency is the level of success that businesses or banks achieve in allocating usable inputs and the outputs they produce to meet predetermined goals.

Maybe you are interested!

From a theoretical perspective, Systems Theory holds that “efficiency can be understood in two aspects:

- The ability to transform inputs into outputs or profitability or reduce costs to increase competitiveness with other financial institutions.

- Verify the safety of bank operations.

Thus, banking business performance is a category that reflects the combination and reasonable allocation of resources, technological changes, skill levels, management levels, reflecting the comparable relationship between economic results and costs incurred to achieve those results.

In short, the business performance of commercial banks is to gain maximum profit with minimum cost. This is also the goal that banks need to achieve in business activities.

1.2.2. Indicators for measuring the business performance of commercial banks

To evaluate the business performance of a bank, people often use 3 profit-related indicators as follows:

1.2.2.1. Return on equity (ROE ): equals net profit divided by average basic equity (common equity, preferred equity, reserves and undistributed profits).

ROE measures the rate of return to the bank's shareholders. It represents the income that shareholders receive from their capital investment in the bank.

ROE=

In the studies of Irshad and Zaman (2011); Abuzar (2013); ROE is used as a dependent variable to analyze factors affecting the profitability of banks. ROE depends on factors such as: assets, equity, customer deposits, costs over income... The larger the capital structure mobilized over total assets, the smaller the bank's equity ratio. Therefore, the return on equity will give positive results but cannot reflect the risks that may occur later. A high ROE ratio cannot confirm the bank's good business performance and a low ROE ratio cannot confirm that the bank is operating inefficiently.

1.2.2.2. Return on assets (ROA) : ROA is an indicator to evaluate the effectiveness of a bank's management, showing the ability to convert the bank's assets into net income.

ROA=

ROA is a financial ratio used to measure the bank's ability to generate profit per dollar of assets. If this ratio is greater than 0, it means that the bank is profitable. A higher ratio shows that the bank is more efficient. If the ratio is less than 0, the bank is losing money. The profit or loss is measured as a percentage of the average value.

Total assets of the bank. The ratio shows the efficiency of management and use of assets to generate income of the bank.

Syfari (2012), Abuzar (2013) used ROA ratio to measure the profitability of banks. The results showed that ROA depends on many factors such as: operating costs, liquidity, bank size, credit risk, deposit size, inflation, economic growth, money supply, etc.

1.2.2.3. Relationship between ROE and ROA

ROE= ROE=

ROE= ROA x

In there:

Financial leverage ratio =

The above relationship shows that a bank's earnings are very sensitive to the way it finances its assets (using more debt or more equity). A bank with a low ROA can still achieve a high ROE if it uses more debt (including customer deposits) and uses a minimum of equity in financing its assets.

1.2.2.4. Marginal Revenue Ratio : Measures Efficiency and Profitability

- Net interest margin (NIM) : Is the difference between interest income and interest expense, all divided by the interest product. The net interest margin is closely monitored by bank owners because it helps the bank predict the bank's profitability through strict control of earning assets and finding the lowest cost sources of capital. The higher the NIM, the more profitable the bank is. NIM is calculated by the following formula:

Net profit margin =

The interest margin is of interest to bank managers because it helps banks predict their profitability by closely controlling their earning assets and finding low-cost sources of capital. Dietrich and Wanzenried (2011) used the interest margin as a dependent variable in their studies of factors affecting bank profitability.

Non-interest Margin (MN): Measures the difference between non-interest income (service fees) and non-interest expenses (salaries, repairs, equipment warranties, credit loss expenses, etc.)

MN =

(Most NM banks are often negative)

- Operating Profitability Ratio (NPM): Reflects the effectiveness of cost management and service pricing policies:

NPM =

1.2.3. Factors affecting the business performance of commercial banks

1.2.3.1. Factors within the bank

Internal factors affecting the performance of a bank are factors affected by subjective decisions of the bank's management. These factors include: Bank asset size, equity size, customer deposit size, credit activities and credit risk, business diversification level, operating costs, information technology.

1.2.3.1.1. Size of bank assets.

The size of bank assets is the result of the use of capital in the bank, which are assets formed from the bank's capital sources during its operations. The components of assets include: treasury, credit portfolio, investment portfolio, fixed assets and other assets. To maximize profits, minimize risks

To ensure liquidity and profitability, the Bank always pays attention to implementing the strategy of diversifying asset categories to disperse risks, best resolving the relationship between liquidity and profitability in asset categories and ensuring flexible transformation of value between asset categories to help the Bank always have an asset portfolio that is suitable for fluctuations in the business environment.

Most banks with large asset size will have more favorable opportunities in the process of expanding the distribution channel of products and services, thereby saving transaction costs, thereby increasing profits. However, when the size of the bank is too large, the management of this asset will require highly qualified human resources and incur high costs in management and operation, which may reduce profits. The research results of Fadzlan Sufia and Royfaizal Razali Chong (2008) in the Philippines and of Syafri (2011) in Indonesia, found a negative correlation between bank size and profitability. Meanwhile, the research results of Sufian (2011) in Korea; Alper and Anbar (2011) in Turkey, Irshad and Zaman (2011) in Pakistan found a positive correlation between bank size and profitability.

1.2.3.1.2. Size of bank equity

Bank equity includes the following components: Charter capital, reserve funds and provisions, and some other liabilities as prescribed by the State Bank. Equity provides financial resources for the bank to operate during the initial period of operation, which is the period when the bank has not yet received deposits from customers, helping the bank to cope with risks when they arise. Equity is a stable source of capital and always grows during the bank's operations, can be used for a long term without having to repay, so it is the foundation for the bank's growth. The bank's equity accounts for a small proportion of the total business capital (usually from 10% to 15%), but it plays a very important role because it is the basis for forming other sources of capital for the bank and at the same time creating initial reputation.

maintain public confidence in banks. Equity determines the scale of bank operations, and is also a factor for management agencies to rely on to determine safety ratios in banking business (Capital mobilization limits, lending limits, investment limits in fixed assets, etc.). Therefore, to improve resistance to risks and bankruptcy risks in business, banks must maintain stability and increase equity capital reasonably.

1.2.3.1.3. Customer deposit size

Customer deposits are deposits of businesses and individuals into bank accounts. Customer deposits include demand deposits and term deposits with many different terms. The larger the deposit size, the greater the bank's ability to use capital. The larger the deposit ratio compared to assets, the more capital the bank has to finance credit activities, contributing to the bank's profits. However, for each source of mobilized capital, banks need to pay attention to two important issues: the cost of obtaining capital and the risk of each source of capital. Different capital mobilization terms will correspond to different levels of risk and corresponding to different interest payment costs. Therefore, capital mobilization activities need to have a reasonable interest rate policy to be able to both attract deposits from customers and ensure the profitability of commercial banks.

1.2.3.1.4. Credit activities and credit risks

Credit activities are activities using bank capital to finance the borrowing needs of entities lacking capital in the economy. This is a very important activity and it is also the traditional business activity of the bank because it attracts most of the bank's capital sources (60-70%) bringing 2/3 of the total income for the bank and is an activity that contains a lot of risks, through which the level and business efficiency of the bank can be assessed. Credit activities are carried out through many forms such as: lending, discounting valuable papers, financial leasing, guarantees, factoring. These activities will bring profits to the bank from interest income.

loans. When banks expand credit, it means that interest income will increase and the bank's profits will also increase accordingly. However, when credit growth is not accompanied by strict control of credit quality, risks will appear. When credit risks occur, banks cannot collect the credit capital granted and the loan interest, but the bank must pay the principal and interest on the mobilized money when due, which causes the bank to lose balance in revenue and expenditure. When debt cannot be collected, the credit capital turnover slows down, making the bank's business ineffective and possibly losing liquidity. At the same time, risk provisions increase, thereby increasing operating costs and reducing the bank's profits.

1.2.3.1.5. Level of business diversification

In addition to traditional activities of capital mobilization and credit granting, banks also carry out many other business activities such as: financial investment, foreign exchange trading, payment services, treasury services, trust services, asset custody services, consulting services, cross-selling insurance products, etc. These activities are a safe source of income for commercial banks because when performing these services, banks not only do not encounter many risks but also collect service fees. When diversifying business activities, banks will have more income, thus reducing dependence on credit interest income with many potential risks.

1.2.3.1.6. Banking operating costs

Operating expenses are expenses incurred during the normal operation of a bank, including tax payments, fees, charges, salaries, allowances, employee benefits, property expenses, administrative expenses, customer deposit insurance, and provisions (excluding provisions for credit risks and securities depreciation). The higher the operating expenses of a bank, the lower its profitability.

1.2.3.2. Factors outside the bank

External factors affecting the performance of banks are factors beyond the control of bank managers. These factors include: economic growth rate, inflation rate, etc.

1.2.3.2.1. Economic growth rate

Economic growth rate is shown through the increase in GDP or GNP or per capita income in a certain period of time. When the economy develops, individuals and businesses will have more opportunities to expand production and business activities, so there will be more demand for credit capital compared to a recessionary economy. And when businesses make a profit, the ability to repay principal and interest on time will be higher, the bad debt ratio will accordingly decrease, contributing to minimizing credit risks for banks.

. This may increase the profitability of banks. On the contrary, economic downturn may cause more losses to banks due to increase in non-performing loans. Gul, Irshad and Zaman (2011); Syfari (2012) have provided evidence that economic growth increases bank profitability. On the other hand, Ayadi and Boujelbene (2011) study showed negative correlation. Economic growth increases competitive pressure for commercial banks and the result of this impact is a decrease in profitability.

1.2.3.2.2. Inflation rate

Inflation is the loss of market value or purchasing power of money, it is an important macroeconomic indicator to measure the risk in business operations. When inflation is high, banks tend to increase credit interest rates higher than deposit interest rates, which will increase the bank's profits. However, if inflation occurs unexpectedly and the bank does not adjust interest rates in time, the bank's costs may increase faster than income and thereby negatively affect profits. Inflation causes instability in the economy, making the bank's risks increase and profits decrease.

Comment