Analyzing banks is difficult as they are a substantially different business from most other firms. Loans are assets while deposits are liabilities – it’s a topsy-turvy world. You are going to need all the help that you can get. Here are just 3 ratios which are specific to banks.
Provision for Loan Loss Ratio (PLL Ratio)
The PLL ratio is an asset quality ratio that measures a bank’s exposure to credit risk. The Provision for Loan Loss account measures charge-offs for loans which are deemed to be uncollectible by the bank. A higher PPL ratio implies poorer asset quality and a more aggressive, risk-taking behaviour which makes more risky loans. However, different banks may have different ways of determining whether a loan is uncollectible which may skew their PPL ratio in either way. Also, as with most provisions, charge-offs are entirely reversible if the loan is repaid in the future.
Temporary Investments Ratio
The Temporary Investments Ratio measures the liquidity of a bank. Temporary investments include federal funds sold, amount due from banks and any investment that has a period of less than 1 year. A high value indicates high liquidity which is a vital aspect of bank management, especially when shocks happen.
Volatility Liability Dependence Ratio
This liquidity ratio measures the extent to which a bank’s riskiest assets are funded by the most unstable liabilities. Volatile liabilities are “hot” or “unstable” funds that can disappear from a bank’s balance sheet overnight. These include brokered deposits, deposits in foreign offices, fed funds purchased and other uninsured borrowings. Therefore, a lower ratio implies a safer asset base which is less susceptible to external shocks.