Equity Research Banking Financial Ratios: NIM, Efficiency Ratio, CET1, and 12 More Critical Metrics for Interviews

Mastering Banking Ratios for Equity Research Interviews

Banking ratio analysis is the specific dialect spoken on Wall Street. While anyone can pull data from a Bloomberg terminal, the difference between a junior candidate and a hired analyst is the ability to interpret the story behind the numbers.

Does a 51% Efficiency Ratio signal elite cost control, or is the bank underinvesting in technology? Why does a 130 basis point spike in Non-Performing Assets (NPAs) set off alarm bells that a simple dip in earnings might not?

This guide breaks down the 15 critical ratio analysis concepts that dominate banking sector interviews. We are moving beyond simple formulas to develop the analytical judgment interviewers crave.

1. The "Big Five" You Must Know Cold

In an interview, you don’t have time to fumble with definitions. There are five ratios you need to recall instantly. If you hesitate here, the interviewer assumes you don't grasp the basics.

• Net Interest Margin (NIM) = Net Interest Income / Average Earning Assets

• Efficiency Ratio = Non-Interest Expense / Revenue

• CET1 Ratio = CET1 Capital / Risk-Weighted Assets

• Return on Assets (ROA) = Net Income / Average Assets

• Loan-to-Deposit Ratio (LDR) = Loans / Deposits

Insight: Don't just memorize the math; practice calculating these continuously until it feels like second nature. Interviewers love to rapid-fire these questions to test your composure under pressure.

2. Context is King: Defining Good vs. Bad

Calculating a number is useless if you don't know where it sits in the competitive landscape. If you tell an interviewer a bank has a 58% Efficiency Ratio, they will ask, "Is that good?"

You need to know the benchmarks by heart:

• Efficiency Ratio: Below 55% is elite; 60-65% is acceptable; anything above 65% suggests operational bloat.

• NIM: For commercial banks, 2.5%–3.0% is healthy. Below 2.0% suggests margins are being compressed.

• CET1: Anything above 11% gives the bank a "war chest" for growth. Dip below 8%, and regulators get involved.

Use these thresholds to show you possess judgment, not just a calculator.

3. Fluency in Basis Points

Banking analysis lives and dies in basis points (bps). You need to be fluent in this language.

If funding costs rise by 0.50%, that is a 50 bps increase. If the NPA ratio jumps from 2.1% to 3.4%, do not say "it went up 1.3 percent." Say, "it deteriorated by 130 basis points."

Quick Math Check: If a bank has $95 billion in assets and funding costs rise by 75 bps, you should be able to estimate a roughly $713 million impact without reaching for your phone. Speed demonstrates mastery.

4. DuPont Analysis: Peeling Back the Layers of ROE

A high Return on Equity (ROE) looks great on paper, but how did the bank achieve it? This is where DuPont Analysis separates the pros from the amateurs.

ROE = Net Margin × Asset Turnover × Equity Multiplier

Banks usually have low asset turnover (massive balance sheets relative to revenue). Therefore, high ROE is often driven by leverage (the Equity Multiplier). If you see an ROE of 14%, dig deeper. Is it driven by operational excellence (Margin) or dangerous risk-taking (Leverage)?

5. The "What If" Game: Sensitivity Analysis

Interviewers love to throw curveballs. They want to see if you can model scenarios in your head.

• "What happens to the CET1 Ratio if $20 billion in corporate loans default?" (Hint: Both the numerator and denominator change).

• "If the Efficiency Ratio is 61% and we get 4% operating leverage, where do we land next year?"

This is called Operating Leverage the holy grail of banking efficiency. If revenue grows 7% but expenses only grow 3%, the bank becomes more profitable with scale. Being able to project these shifts proves you understand the business model, not just the snapshot.

6. Asset Quality and the Red Flags

When analyzing Provision Coverage Ratios, one size does not fit all.

A 65% coverage ratio might be fine for a commercial bank with secured real estate loans (where recovery rates are high). But for a credit card issuer like Capital One? That same 65% is terrifying because unsecured debt is rarely recovered.

Watch out for the "silent killers." A 130 bps increase in NPAs in a single quarter isn't just a bad quarter; it’s a catastrophe. It suggests that underwriting standards have failed or a hidden economic shock is surfacing.

7. Valuation Nuances: Tangible Book Value

In general equity research, Price-to-Earnings (P/E) is standard. In banking, we obsess over Price-to-Tangible Book Value (P/TBV).

Here is the trap candidates fall into: they subtract Goodwill but forget Intangibles.

• Correct Math: Total Equity - Goodwill - Intangible Assets = Tangible Book Value

This adjustment matters. A bank might look cheap at 0.92x Price-to-Book, but expensive at 1.20x Price-to-Tangible Book. Always clarify which metric you are using.

8. Basel III and Capital Strategy

Finally, you must understand the regulatory floor. Under Basel III, banks generally need a minimum CET1 of 7.0% (4.5% base + 2.5% conservation buffer).

Why does this matter to an investor? Because of Excess Capital.

If a bank is sitting at 11.84% CET1 against a 7% requirement, that 4.84% excess represents billions of dollars in Lending Capacity. You can calculate exactly how much new lending that capital can support. This tells you if the bank is ready to grow, acquire competitors, or return cash to shareholders via buybacks.

Our Thought: Whether you are looking at JPMorgan Chase or a regional lender, these ratios are the foundation of your investment thesis. The goal isn't just to calculate the number it's to tell the investor what that number means for the future of the stock.

Interview Questions on Ratio Analysis and Performance Metrics

1. The Net Interest Margin (NIM) Squeeze

Question: A bank reports Net Interest Income (NII) of $2.8 billion on average earning assets of $95 billion. Calculate NIM. If funding costs increase 50 basis points (bps), what is the new NIM assuming asset yields remain unchanged?

Calculation:

Current NIM = $2.8 billion / $95 billion = 2.95%

Cost Impact = $95 billion * 0.50% = $475 million increase in expense

New NII = $2.8 billion - $0.475 billion = $2.325 billion

New NIM = $2.325 billion / $95 billion = 2.45%

Suggested Answer:

"First, the baseline NIM is 2.95%. The critical part is the sensitivity. A 50 basis point increase in funding costs on $95 billion of assets increases interest expense by $475 million.

This reduces our Net Interest Income to $2.325 billion. Dividing that by the asset base gives us a new NIM of 2.45%. Essentially, we are looking at a pure 50 bps margin compression that wipes out nearly half a billion dollars in annual profit."

Mentor Tip:

Notice how the answer didn't just give the number? It quantified the dollar impact ($475 million). Interviewers want to know that you understand the consequences of the math. This is exactly what happened to regional banks in 2023 when rate hikes outpaced their ability to reprice loans.

2. The Efficiency Ratio Test

Question: Calculate the Efficiency Ratio for a bank with Non-Interest Expense of $4.2 billion, Net Interest Income of $5.8 billion, and Non-Interest Income of $2.4 billion. Is this good or bad?

Calculation:

Total Revenue = $5.8 billion + $2.4 billion = $8.2 billion

Efficiency Ratio = $4.2 billion / $8.2 billion = 51.2%

Suggested Answer:

"The total revenue is $8.2 billion. Dividing expenses of $4.2 billion by that revenue gives us an Efficiency Ratio of 51.2%.

This indicates the bank spends roughly 51 cents to generate every dollar of revenue. In the current banking environment, this is elite performance. While the industry average hovers between 55-60%, a ratio near 50% puts this bank in the top quartile, comparable to highly efficient operators."

Mentor Tip:

Always benchmark your answer. If you just say "51.2%," the answer is incomplete. You must frame it against the industry standard (approx 60%) to show you understand the competitive landscape.

3. Capital Adequacy & The Death Spiral

Question: A bank has CET1 Capital of $45 billion and Risk-Weighted Assets (RWA) of $380 billion. Calculate the CET1 ratio. What happens if $20 billion of corporate loans default?

Calculation:

Current CET1 Ratio = $45 billion / $380 billion = 11.84%

New Capital (post-default) = $45 billion - $20 billion = $25 billion

New RWA (write-off) = $380 billion - $20 billion = $360 billion

New CET1 Ratio = $25 billion / $360 billion = 6.94%

Suggested Answer:

"Currently, the bank has a robust CET1 Ratio of 11.84%, which is well above the regulatory requirement of 7%.

However, a $20 billion default is catastrophic. The loss is written off against capital, dropping CET1 to $25 billion. The defaulted loans are removed from RWA, lowering the denominator to $360 billion.

The new ratio plummets to 6.94%. This breaches the 7% regulatory minimum, likely triggering a 'death spiral' of dividend cuts, forced capital raises, and regulatory intervention."

Mentor Tip:

This is a trick question regarding the denominator. Many candidates forget to subtract the defaulted loans from the Risk-Weighted Assets. Remember: if a loan is written off, it is no longer an asset, so it leaves the RWA calculation.

4. Liquidity Logic (Loan-to-Deposit)

Question: Calculate the Loan-to-Deposit Ratio (LDR) for a bank with $180 billion loans and $210 billion deposits. What does this indicate?

Calculation:

LDR = $180 billion / $210 billion = 85.7%

Suggested Answer:

"The LDR is 85.7%. This indicates a healthy, conservative balance sheet. The bank has lent out roughly 86 cents of every dollar on deposit, leaving a 14% liquidity buffer. It implies the bank is well-funded by stable deposits and has significant room to grow its loan book without relying on expensive wholesale funding."

Mentor Tip:

Context is everything. An LDR above 100% signals danger (reliance on wholesale funding), while an LDR below 60% signals inefficiency (too much idle cash). 80-90% is the "Goldilocks" zone.

5. Deconstructing ROE (DuPont Analysis)

Question: A bank's ROE is 14%. Break this down using DuPont Analysis given a Net Margin of 18% and Asset Turnover of 0.06. What is the Equity Multiplier?

Calculation:

Formula: ROE = Margin Turnover Equity Multiplier

Substitute: 14% = 18% 0.06 Equity Multiplier

Simplify: 14% = 1.08% * Equity Multiplier

Solve: 14 / 1.08 = 12.96x

Suggested Answer:

"Using the DuPont framework, we know that 14% ROE equals the 18% margin times 0.06 turnover times the Equity Multiplier. Solving for the multiplier, we get 12.96x.

This tells me the bank's double-digit return is driven largely by leverage. For every $1 of equity, they hold nearly $13 in assets. While 14% ROE looks strong, it carries significant balance sheet risk compared to a bank achieving that return through operational efficiency."

Mentor Tip:

Banks always have low asset turnover (huge balance sheets vs. revenue). The interviewer is testing if you understand that high banking ROE usually comes from leverage, not turnover.

6. The Provision Coverage Red Flag

Question: Calculate the Provision Coverage Ratio if a bank has Gross NPAs of $8 billion and Provisions of $5.2 billion. Is 65% coverage adequate for a retail bank?

Calculation:

PCR = $5.2 billion / $8 billion = 65%

Suggested Answer:

"The coverage ratio is 65%. For a retail bank heavily exposed to unsecured lending (like credit cards), 65% is marginal to weak.

Unlike secured loans where you can seize property, unsecured recovery rates are often only 20-40%. If the economy turns, this bank is under-reserved and will face a massive hit to earnings to catch up."

Mentor Tip:

Differentiate between business models. 65% might be okay for a commercial bank with collateralized real estate loans. For a credit card bank? It is a disaster waiting to happen.

7. ROA and Business Models

Question: A bank generates Net Income of $850 million on Average Assets of $115 billion. Calculate ROA. Compare this to Goldman Sachs' typical ROA of ~1%.

Calculation:

ROA = $850 million / $115 billion = 0.74%

Suggested Answer:

"The ROA is 0.74%. Compared to Goldman Sachs (1%), this bank is underperforming. Goldman achieves a higher ROA because of fee-based businesses (M&A, Wealth Management) that generate high revenue with minimal assets.

A 0.74% ROA suggests this is a traditional, asset-heavy commercial bank. To improve valuation, they need to either optimize the balance sheet or grow fee income."

Mentor Tip:

Investment banks run "asset-light" (High ROA). Commercial banks run "asset-heavy" (Lower ROA). Showing you understand this structural difference impresses interviewers.

8. The "Tangible" Trap

Question: Calculate Tangible Book Value (TBV) per share: Total Equity $65B, Goodwill $12B, Intangibles $3B, Shares 2.5B.

Calculation:

Tangible Equity = $65 billion - $12 billion - $3 billion = $50 billion

TBVPS = $50 billion / 2.5 billion shares = $20.00 per share

Suggested Answer:

"We must subtract both Goodwill and Intangibles. The Tangible Equity is $50 billion. Divided by 2.5 billion shares, the Tangible Book Value is $20.00 per share.

This is crucial for valuation because if the bank fails, that $15 billion in intangible assets evaporates. Investors pay for the tangible equity."

Mentor Tip:

Candidates often subtract Goodwill but forget Intangibles. Don't make that mistake. Also, note that banks trade on multiples of TBV, not just Book Value.

9. Interpreting Credit Deterioration

Question: A bank's NPA Ratio increased from 2.1% to 3.4% quarter-over-quarter. Calculate the basis point increase.

Calculation:

Increase = 3.4% - 2.1% = 1.3%

Conversion = 1.3 percentage points = 130 basis points

Suggested Answer:

"That is a 130 basis point deterioration in a single quarter.

This is not just 'noise'; it is a siren. A jump of that magnitude suggests a systemic failure in underwriting or a sudden economic shock the bank wasn't prepared for. We should expect heavy provisioning expenses in the next earnings call, which will crush profitability and potentially put dividend payments at risk."

Mentor Tip:

Use strong language here. A 130 bps jump isn't "bad" it is "catastrophic." It signals that management has lost control of credit quality.

10. Net Interest Spread & Funding Mix

Question: Calculate Net Interest Spread: Loan Yield 5.8%, Securities Yield 3.2%, Deposit Cost 2.1%, Wholesale Cost 3.8%. (Mix: 60/40 Assets, 70/30 Liabilities).

Calculation:

Asset Yield = (5.8% 0.6) + (3.2% 0.4) = 3.48% + 1.28% = 4.76%

Funding Cost = (2.1% 0.7) + (3.8% 0.3) = 1.47% + 1.14% = 2.61%

Spread = 4.76% - 2.61% = 2.15%

Suggested Answer:

"The Net Interest Spread is 2.15%. This is a healthy spread, largely driven by the cheap deposit funding (70% of liabilities). If the bank loses deposits and has to rely more on wholesale funding, that 2.15% spread will compress rapidly."

Mentor Tip:This calculation proves why deposits are so valuable. They are the cheapest source of funding. If a bank loses deposits, they must use expensive wholesale funding, destroying the spread.

11. The Multiplier Effect of Excess Capital

Question: A bank has a Tier 1 Ratio of 11.5% against a minimum of 8.5%. How much additional lending capacity does this provide? (Assume current RWA of $400B).

Calculation:

Excess Ratio = 11.5% - 8.5% = 3.0%

Excess Capital ($) = $400 billion * 3.0% = $12 billion

Lending Capacity = $12 billion / 8.5% = $141.2 billion

Suggested Answer:

"The bank has a 3.0% excess capital buffer, which equates to $12 billion in excess capital.

To find the lending capacity, we divide that excess by the minimum requirement: $12B / 8.5% = $141 billion. Ideally, the bank can grow its loan book by over $140 billion without raising a single dollar of new equity. This represents massive optionality for growth or acquisitions."

Mentor Tip:

This is the "magic" of banking. $12 billion in cash supports $141 billion in lending. This concept is called the Money Multiplier effect of capital buffers.

12. Growth vs. Income Strategy

Question: A bank earns $3.50/share and pays a $1.40 dividend. Calculate the payout and retention ratios. What is the implied growth strategy?

Calculation:

Payout Ratio = $1.40 / $3.50 = 40%

Retention Ratio = 1 - 40% = 60%

Sustainable Growth (assuming 14% ROE) = 14% * 60% = 8.4%

Suggested Answer:

"The Payout Ratio is 40%, leaving a Retention Ratio of 60%.

This signals a Growth Strategy. By retaining 60 cents of every dollar, the bank is reinvesting heavily in its loan book or technology. If they maintain a 14% ROE, this retention rate supports sustainable growth of 8.4% annually without needing external capital."

Mentor Tip: Mature banks (utilities) payout 60-70%. Growth banks payout 20-40%. The ratio tells you the management's confidence in their future growth opportunities.

13. The "Jaws" of Operating Leverage

Question: A bank has positive 4% Operating Leverage (Rev +7%, Exp +3%). If the current Efficiency Ratio is 61%, project it for next year.

Calculation:

Base (Year 0): Revenue = 100, Expense = 61

Year 1 Revenue = 100 * 1.07 = 107

Year 1 Expense = 61 * 1.03 = 62.83

New Efficiency Ratio = 62.83 / 107 = 58.7%

Suggested Answer:

"The ratio improved to 58.7%. The ratio improved by 230 basis points. This demonstrates the power of positive operating leverage growing the top line faster than the fixed cost base is the fastest way to expand margins."

Mentor Tip: Analysts call this "Jaws" (because the chart lines open up like a shark's mouth). Positive jaws drive P/E multiple expansion because it proves the business model scales.

14. Valuation: Paying for Quality

Question: A bank trades at $48 with a Book Value of $52 and Intangibles of $8. Calculate Price-to-Tangible Book (P/TBV). Is 1.09x cheap?

Calculation:

Tangible Book = $52 - $8 = $44

P/TBV = $48 / $44 = 1.09x

Suggested Answer:

"The P/TBV is 1.09x. Whether this is 'cheap' depends on ROE. If the bank earns a 10% ROE, 1.09x is fair value. If they earn a 15% ROE, 1.09x is a steal. However, looking purely at the multiple, it trades at a slight premium to liquidation value, which typically implies a stable, but perhaps low-growth, franchise."

Mentor Tip: P/TBV is the single most important valuation metric for banks. Remember: ROE drives P/TBV. You pay a higher multiple for higher returns.

15. The Basel III Leverage Constraints

Question: A bank has a Basel III Leverage Ratio of 5.2% (Tier 1 Cap $42B / Total Exposure $808B). Verify calculation and assess compliance.

Calculation:

Leverage Ratio = $42 billion / $808 billion = 5.2%

Suggested Answer:

"The calculation is correct at 5.2%. While this clears the Basel III minimum (3%) and the US G-SIB standard (5%), it is extremely tight.

A 20 basis point buffer is razor-thin. If the bank's derivatives exposure increases or they take a small loss, they could breach regulatory limits. This bank is capital constrained and likely cannot grow its balance sheet without raising equity."

Mentor Tip: Don't confuse the Leverage Ratio with the CET1 Ratio. CET1 uses Risk-Weighted Assets (RWA). Leverage Ratio uses Total Exposure (no risk weighting). It is the backstop to prevent banks from gaming their risk models.

Final Thoughts

If there is one takeaway from this guide, it is this: Banking Ratio Analysis is not a math test; it is a test of your ability to diagnose a business.

The 15 questions we covered from Net Interest Margin (NIM) sensitivity to Basel III compliance are the toolkit. But the tools are useless if you don't know how to build the house. The equity research interviewers at firms like Goldman Sachs or JPMorgan aren't looking for human calculators; they are looking for risk managers and detectives.

The Difference Between "Correct" and "Hired" The "correct" candidate calculates that a bank’s Efficiency Ratio improved from 61% to 58.7%. The hired candidate explains why it matters: "That improvement was driven by positive Operating Leverage revenue grew faster than expenses. This suggests the bank has a scalable platform, justifying a multiple expansion."

Build Your Mental Dashboard You need to reach a point where these numbers aren't abstract figures, but instant signals of health or sickness. Practice until these benchmarks are automatic:

• 51% Efficiency: Elite execution.

• 130 bps NPA Spike: A massive red flag signaling credit deterioration.

• 11.84% CET1: A fortress balance sheet with room for buybacks.

• 0.74% ROA: Underperformance that demands a turnaround strategy.

Connecting the Dots Finally, remember that no ratio lives in a vacuum. A high ROE is often just high leverage in disguise (as DuPont Analysis reveals). A high Dividend Payout Ratio might look generous, but it cripples the Retention Ratio, mathematically capping the bank's sustainable growth rate.

When you walk into that interview, don't just give the answer give the implication.

Don't just say: "The NIM is 2.95%." Say: "At 2.95%, the margin is healthy. However, a 50 bps compression would wipe out $475 million in profit, or roughly 15% of net income. If I were analyzing this stock, I’d want to know how aggressively they are hedging that interest rate risk."

That is the level of insight that separates the junior analysts from the crowd. Good luck.