Skip to content
Sem 5 Prep
← Money & BankingValuing a bank and scoring it

Formulas for this chapter

Bank valuation with a terminal value

V = SUM E(CFt) / (1 + k)^t CF(n+1) = CF(n) x (1 + g) TV at year n = CF(n+1) / (k - g) PV(TV) = TV / (1 + k)^n V = PV(forecast years) + PV(TV)

Any bank valuation question. Discount each year separately, grow the last forecast year once to get the terminal numerator, and discount the terminal value by (1+k)^n where n is the last forecast year.

E(CFt)
Expected free cash flow to equity in period t
k
Required rate of return, that is the cost of equity
g
Stable terminal growth rate, which must be less than k

Profitability ratios

NII = interest earned - interest expended NIM = NII / earning assets Earning assets = gross advances + all investments + balances with banks Cost-to-income = operating expenses / (NII + other income) ROA = PAT / total assets ROE = PAT / (share capital + reserves) Loan-to-assets = gross advances / total assets ICR = EBIT / interest expense ROE = ROA x leverage

Reading a bank's P&L. Watch three denominators: earning assets exclude cash and fixed assets, total income is NII plus other income, and ROA uses total assets while NIM uses earning assets only.

gross advances
Net advances plus closing provisions
leverage
Total assets divided by equity

Liquidity ratios

CD ratio = gross advances / total deposits LCR = HQLA / net cash outflows over 30 days (min 100%) HQLA = cash with RBI + HFT + 70% of AFS Net outflows = 10% of deposits + 15% of borrowings SLR = government securities / NDTL (req ~18%) CRR = cash with RBI / NDTL (req ~4.5%)

Scoring a bank on liquidity. NDTL is approximated by deposits in the professor's problem. Government securities for the SLR are HTM plus 70% of AFS.

HQLA
High-quality liquid assets, convertible into cash easily and quickly
run-off rate
Fraction of a funding source assumed to leave in a 30-day stress

Capital adequacy

CET1 = share capital + reserves and surplus - deductions Total RWA = credit RWA + market RWA + operational RWA Credit RWA = SUM (exposure x risk weight) CET1 ratio = CET1 / total RWA (min 8%) CAR = (Tier I + Tier II) / RWA

Capital questions. Deduct the deferred tax asset before dividing, and add all three RWA categories. Risk weights: government bonds 0%, corporate loans 100%, retail and SME 75%, mortgages about 35% to 50%.

deductions
Items that cannot absorb loss, notably the deferred tax asset
risk weight
Regulatory multiplier reflecting the riskiness of the counterparty
Step 1 of 30
The ideaTheory

What a bank is worth

A mango tree is worth the mangoes it will produce, brought back to today's money because next year's mango is worth less than this year's.

A bank is worth the cash it will eventually hand to its owners, discounted the same way. Nothing else.

The rest of this chapter is the check-up: eleven ratios that say whether those cash flows are likely to arrive at all.

← BackContinue →