Sector AnalysisIntermediate
Special Financial Metrics for Banks
A practical guide to bank-specific metrics like NIM, efficiency ratio, CET1, LDR, and NPLs, and how to use them.
InvestTracker
8 min read
BankingFinanceSector
Table of Contents
Banks are different from most companies. A typical manufacturer sells products; a bank mostly sells money. It pays interest to depositors and earns interest from borrowers and securities. The spread between what it earns and what it pays is its economic engine. Because of this, traditional metrics like gross margin or inventory turns are less useful. Instead, investors focus on interest spreads, credit quality, capital strength, and liquidity.
Two pillars support most bank earnings. First is net interest income, the difference between interest income from loans and securities and interest expense on deposits and borrowings. Second is non-interest income, such as fees from payments, wealth management, and trading. Together, they form a bank's OperatingRevenues in practice.
Risk is central. Banks use leverage: a small equity base supports a large asset base. That makes capital adequacy and asset quality crucial. Metrics like the CET1 capital ratio and non-performing loan ratio tell you how well a bank can absorb losses. Liquidity metrics show whether the bank can fund itself reliably.
Put simply: bank analysis is about spreads, costs, credit, capital, and liquidity. Understand those, and you can evaluate most banks with confidence.
The market often assigns similar price-to-earnings ratios to banks with very different risk profiles. Without sector-specific metrics, you might miss why one bank deserves a premium. For example, a bank with the same earnings as a peer could be safer if its capital ratio is higher, its loan losses are lower, and its funding is more stable. The difference shows up when the cycle turns.
Bank results are sensitive to interest rates. When rates move, deposit costs and loan yields adjust at different speeds. Banks with strong core deposits may protect margins better than those reliant on expensive wholesale funding. Understanding NIM, deposit betas, and balance sheet mix helps you anticipate earnings changes instead of reacting to them.
Finally, valuation in banks often ties to NetAssets and their quality. Tangible book value and return on equity hinge on credit costs and capital. If you understand what drives those, you can judge whether a bank can sustain its ROE and whether a discount to tangible book is a bargain or a value trap.
Below are the core bank metrics, with formulas and plain-language steps.
Net Interest Income (NII) and Net Interest Margin (NIM)
Steps:
Non-Interest Income (NIR)
Efficiency Ratio
Steps:
Credit Cost (Provision Expense) and Cost of Risk
Asset Quality: NPL Ratio and Provision Coverage
Connecting to OperatingRevenues and NetAssets:
Imagine Bank Alpha with the following annual data (in millions):
Step-by-step calculations:
Interpretation:
Screening for quality
Rate-sensitivity assessment
Valuation cross-checks
Growth vs. risk balance
Dividend and buyback capacity
Peer benchmarking
Net Interest Income (NII): Interest income minus interest expense; the dollar amount of spread earnings.
Net Interest Margin (NIM): NII divided by average earning assets; spread efficiency scaled by assets.
Non-Interest Income (NIR): Fees and other income not derived from interest, such as payments and wealth fees.
Efficiency Ratio: Non-interest expense divided by total revenue (NII + NIR); lower indicates better cost control.
Cost of Risk: Provision for credit losses divided by average loans; measures credit cost intensity.
Non-Performing Loan (NPL) Ratio: Non-performing loans divided by total loans; indicates problem loan share.
Provision Coverage: Loan loss allowance divided by NPLs; protection against expected losses.
CET1 Ratio: Common Equity Tier 1 capital divided by risk-weighted assets; core solvency metric.
Tier 1 Leverage Ratio: Tier 1 capital divided by average total assets; non-risk-weighted solvency backstop.
Loan-to-Deposit Ratio (LDR): Loans divided by deposits; indicates funding balance and lending intensity.
Return on Assets (ROA): Net income divided by average total assets; efficiency of asset use.
Return on Equity (ROE): Net income divided by average equity; profitability of shareholder capital.
Tangible Book Value per Share (TBVPS): Tangible common equity divided by diluted shares; a bank valuation base.
AOCI: Accumulated Other Comprehensive Income; includes unrealized gains or losses, affecting tangible equity.
OperatingRevenues: For banks, the sum of net interest income and non-interest income.
NetAssets: Common equity; for banks, the base for ROE and tangible book calculations.
LCR: Liquidity Coverage Ratio; high-quality liquid assets relative to projected short-term net outflows.
NSFR: Net Stable Funding Ratio; available stable funding relative to required stable funding.
Interpretations:
Capital Adequacy: CET1 Ratio and Leverage Ratio
CET1 Ratio = CET1 Capital / Risk-Weighted Assets Tier 1 Leverage Ratio = Tier 1 Capital / Average Total AssetsLiquidity: Loan-to-Deposit Ratio (LDR)
LDR = Loans / DepositsProfitability: ROA and ROE (Bank context)
ROA = Net Income / Average Total Assets ROE = Net Income / Average EquityTangible Book Value per Share (TBVPS)
TBVPS = (Common Equity - Goodwill - Other Intangibles) / Diluted Shares