Banks have certainly gotten more complex over the years. Traditionally, banks used to earn their income solely from interest earned from loans that they offer. However, with modern banks offering more services (such as wealth management, credit cards, investment banking, trading etc), the task of assessing the quality of a bank’s business is now much more challenging.
That said, there are some financial metrics that can help investors broadly assess the quality of a bank’s business. These metrics are by no means a ‘be all and end all’ but they do provide useful information and are easy to compare.
With that in mind, I want to look at three financial metrics and use them to compare the performances of the three banks in Singapore. I will use 2017’s results as a point of comparison.
Return on Equity
The return on equity or ROE is a key profitability ratio to measure how much a company can make on its shareholder’s equity. The average return on equity for companies in the banking industry for the first half of 2017 was 9.75%.
In 2017, the three banks in Singapore, DBS Group Holdings Ltd (SGX:D05), Overseas-Chinese Banking Corporation Limited (SGX:O39) and United Overseas Bank Limited (SGX:O39) had ROEs of 9.31%, 11.2% and 9.72% respectively.
In comparison, OCBC had the best return on equity for the year.
The cost-to-income ratio is a common metric used to assess the cost efficacy of a bank. Mathematically, it is calculated by dividing the expenses of a bank from its income.
DBS, OCBC and UOB had a cost-to-income ratio of 43%, 45.5% and 41.9%. Once again, in terms of maintaining its cost, OCBC had a better ratio than the other two banks.
Finally, the leverage ratio determines how well covered the bank is. It is a measure of the amount of core capital (essentially the money the bank has stored in case of exigencies) against its exposures of all assets. A higher leverage is desirable. According to Basel III regulations, banks are expected to maintain a leverage ratio of 3%.
DBS, OCBC and UOB had leverage ratios of 7.6%, 7.3% and 8.0% respectively. In this regard, all banks are well covered, but UOB has the highest and safest leverage ratio.
The Foolish bottom line
These financial metrics are simple and useful tools that investors can use to compare between banks. That being said, it is important that we do not use these metrics in isolation. There are numerous other aspects of a bank’s business that are not represented by these numbers. Furthermore, the metrics can easily be skewed. For instance, the return on equity number can be skewed if a bank is spending heavily on one-time research and developmental expenses during the year.
Therefore, only by considering all the factors in play are we able to make an informed investing decision.
Meanwhile, Motley Fool Singapore analysts have identified a technology mega-trend we believe investors simply should NOT ignore. Tech revolutions of this magnitude usually come along just once or twice in a lifetime, and the companies at the forefront could make a fortune. Click here now for our comprehensive research report laying out the full story... AND one Asian stock we think is poised to win.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore has a recommendation on DBS Group Holdings and United Overseas Bank Limited. Motley Fool Singapore contributor Jeremy Chia owns shares in DBS Group Holdings.