Paper Example on Money, Banking and Finance

Introduction

Banks currently operate in challenging business environments. Remaining consistently competitive as well as maintaining their profitability goals is certainly dependent on the prudent application of ratio decomposition analysis. Furthermore, banks must continuously maintain as a strong customer base. The Eurozone debt crisis negatively affected several banks, such as D-Bank and th-Bank in England (Coccia, 2018). Following the crisis, the former bank concentrated primarily on improving its balance sheet. Non-performing loans and deteriorating assets had affected its balance sheet. The bank emphasized improving customer service and business loans. As a result, the bank realized steady growth in return to equity ratios. Th-Bank, on the other hand, did not improve its operations leading to a low return on Equity (ROE) and return on assets (ROA). Therefore, it is necessary for the bank manager to apply the technique of ratio decomposition to improve its deteriorating ROE and ROA so that to match its competitor. The rationale behind using ratio-decomposing analysis for the case of Th-Bank is that the approach enables a focus on key financial ratios that highlight the competitive intensity in the financial industry.

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Financial Ratios

The manager should begin the work by critically analyzing the financial decomposition ratios. The approach is appropriate in analyzing financial statements that enable a bank to improve its balance sheet. Furthermore, the ratio measures the return on equity and return on assets. For that reason, it enables a focus on profitability and liquidity ratios. Tarawneh (2006) argues that businesses exist to create wealth for their shareholders. Therefore, the return on equity and return on assets are essential because they indicate the rate at which the shareholders' wealth is rising in the organization. While ratio decomposition analysis is not enough to replace a detailed financial analysis, it provides a better ground to analyze the profitability and liquidity situation of a firm.

Profitability

According to Ahmed (2009), profitability ratios are useful in measuring the rate at which the capital invested in the bank produces profits at all levels of operations such as loans, deposits, and asset management. The assessment of these ratios enables the bank to strategically plan and restructure its financial operations to match its competitors (Kirkpatrick et al., 2007).

Firstly, ROA measures the net profit of a bank concerning its total assets. According to Ahmed (2009), assets indicates the capacity of a bank manager to acquire and retain total amount deposited in the bank at a reasonable cost to invest them in either high return sectors or bonds, which ensures that bank assets are not misused. On the same note, the ratio shows the amount of net income generated as per each Euro of the bank's assets. Therefore, an increase in the ROA increases the profitability of the bank, thus requiring the bank's manager to assess this ratio continuously.

Secondly, ROE measures the net profit generated regarding total equity. It is the most vital tool for assessing bank profitability and aids in decision making concerning profitable ventures in the industry (Kirkpatrick et al., 2007). In other words, the ROE shows the rate of return to stockholders or the percentage value of return on every Euro of equity invested in any given bank. It enables the managers for Th-Bank to utilize the shareholders' funds to invest in high return products to match D-Bank, which has remained profitable despite the Eurozone debt crisis.

Thirdly, ROD measures the profits a bank generates from customers' deposits. The ratio is calculated by dividing the net profits accrued by the total deposits. Adam (2014) asserts that the ROD a crucial financial tool which shows the capacity of a bank to utilize customers' deposits to generate high returns. Therefore, the manager for Th-Bank should ensure better customer services to attract numerous customers and retain the old ones to increase the deposits. For instance, Adam (2014) while studying Erbil Bank discovered that ROD increases the profitability due to rise in deposits. For Th-Bank to compete with D-Bank, the management must apply ROD.

Lastly, a cost to income ratio (C/I) refers to the total expenditure of the bank about the income generated. In other words, it measures the total income generated per unit cost of operation (Kumbirai & Webb, 2010). For that reason, the manager for Th-Bank should ensure that C/I are at the lowest point to yield high performance in the sector.

The above profitability ratios show that the managers of banks should invest in areas that bolster profitability such as granting loans to high-risk customers, which may generate higher profits in a short period than the others. It would enable the bank manager to mitigate the losses due to the Eurozone debt crisis. However, the method may not be appropriate in achieving long-term goals. Tarawneh (2006) indicates that advances and loans in short-term may solve short financial crises but not long-term ones because some customers may default in payments, thus negatively affecting the profitability of a bank. Therefore, the bank manager should cautiously give loans to customers.

Liquidity RatiosLiquidity shows the capacity of an organization to fulfill the outlined financial obligations when they are due. Samad, (2004) indicates that liquidity is the health of any given commercial bank in the world. For a commercial bank to meet its obligations, the manager must analyze all liquidity ratios to determine the financial position of the firm. According to Jahangir, Shill, and Haque (2007), a high percentage of the ratios ensure the financial safety of the bank. The ratios include (TLN/TDP) and (TDP/TA).

The TLN/TDP ratio often used when measuring the liquidity of a bank and the credit risk. Ratio is calculated by dividing total loans by total deposits accrued (Kumbirai & Webb, 2010). On the same note, the ratio indicates the number of bank loans which are funded by customers' deposits. A high percentage ratio points a potential source of the bank's insolvency since the customer's deposits are the stable source of funding. Therefore, the manager for Th-Bank should ensure a thorough campaign to attract many customers to deposit their funds and increase the interest lending rate to discourage borrowing. Subsequently, the bank would be able to survive in debt crisis due to increased deposits.

TDP/TA is another vital financial tool for measuring solvency level of a bank. The ratio has calculated the percentage by dividing total loans total assets (Kumbirai & Webb, 2010). The quotient is a reliable source of funding for a bank. Therefore, it is important for the bank manager to utilize this ratio to stabilize its lending against the Eurozone debt crisis. Furthermore, tools would enable Th-Bank to increase the amounts it gives to customers regarding loans rather relying on bonds or equity. The management of the bank should apply all the financial discussed above to have a competitive advantage and operate sustainably in the market.

References

Adam, M. H. (2014). Evaluating the financial performance of banks using financial ratios- A case study of Erbil Bank for investment and finance. European Journal of Accounting Auditing and Finance Research, 2(6), 162-177.

Ahmed, M., B. (2009). Measuring the Performance of Islamic Banks by Adapting Conventional Ratios. Working Paper, 16, 1-26.

Coccia M. (2018). National Debts and Government Deficits within European Monetary Union: Statistical evidence of economic issues. CocciaLab Working Paper, 34, 10-38.

Jahangir, N., Shill, S., and Haque, M. A. J. (2007) Examination of Profitability in the Context of Bangladesh Banking Industry. ABAC Journal, 27(2).

Kirkpatrick, C., Murinde, V. and Tefula, M. (2007).The measurement and determinants of x-inefficiency in commercial banks in Sub-Saharan Africa. European Journal of Finance 14 (7) 625-639.

Kumbirai, M., & Webb, R. (2010). A financial ratio analysis of commercial bank performance in South Africa. African Review of Economics and Finance, 2(1), 30-53.

Samad, A. (2004). Bahrain Commercial Bank's Performance during 1994-2001. Credit and Financial Management Review 10(1) 33-40.

Tarawneh, M. (2006). A Comparison of Financial Performance in the Banking Sector: Some Evidence from Omani Commercial Banks. International Research Journal of Finance and Economics 3, 103-112.