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Introduction:
The banking sector is the backbone of any economy, but analyzing it can feel like deciphering an intricate puzzle. As an equity research analyst, your ability to break down a bank’s performance, stability, and profitability relies on understanding key financial ratios. These ratios aren’t just numbers they tell the story of a bank’s health, risk profile, and competitive standing in the industry.
Take, for instance, the Tier 1 Leverage Ratio: it reveals the strength of a bank’s core capital relative to its total assets. Or the Net Interest Margin (NIM), a critical measure of how effectively a bank is turning its interest-earning activities into profit. Ratios like the Loan-to-Deposit Ratio (LDR) and the Capital Adequacy Ratio (CAR) help analysts dive deeper, assessing liquidity, operational efficiency, and risk resilience.
In this article, we’ll explore 35 + essential banking sector ratios that every equity research analyst should know. Whether you’re trying to evaluate a bank’s profitability, assess its risk exposure, or make an informed investment recommendation, these metrics will become your trusted toolkit. If you’ve ever wondered how to translate complex financial data into actionable insights, you’re in the right place. Let’s dive in and unlock the power of financial ratios for the banking sector.
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Tier 1 Leverage Ratio in the Banking Sector
The Tier 1 Leverage Ratio measures a bank’s core capital (Tier 1) as a percentage of its average total consolidated assets.
Formula:Tier 1 Leverage Ratio = (Tier 1 Capital) ÷ (Average Total Assets)
Why and When to Use:
Regulatory benchmark under Basel III to ensure banks maintain sufficient core capital to absorb losses.
Unlike risk-weighted ratios, it considers total assets, making it a conservative measure of capital adequacy.
Useful in periods of rapid asset growth to ensure banks are not overleveraged.
Example:A bank with $1 billion in Tier 1 capital and $20 billion in average total assets has a Tier 1 Leverage Ratio of 5%.
Tier 1 Leverage Ratio in the Banking Sector
Total Capital Ratio in the Banking Sector
The Total Capital Ratio measures a bank’s total regulatory capital (Tier 1 + Tier 2) against its risk-weighted assets (RWAs).
Formula:Total Capital Ratio = (Total Regulatory Capital) ÷ (Risk-Weighted Assets)
Why and When to Use:
Indicates overall capital adequacy and the ability to absorb potential losses.
Required by Basel III; typically, a minimum of 8%.
Analysts use it to compare the robustness of different banks.
Example:If a bank has $2 billion in total regulatory capital and $25 billion in RWAs, its Total Capital Ratio is 8%.
Total Capital Ratio in the Banking Sector
Overhead Ratio in Banking
The Overhead Ratio measures operating expenses relative to total operating income.
Formula:Overhead Ratio = (Operating Expenses) ÷ (Operating Income)
Why and When to Use:
Assesses cost efficiency and operational effectiveness.
A lower ratio indicates better expense management.
Useful for benchmarking against peers and monitoring cost control over time.
Example:A bank with $500 million in operating expenses and $1 billion in operating income has an Overhead Ratio of 50%.
Time Deposits to Total Deposits Ratio in the Banking Sector
This ratio shows the proportion of a bank’s deposits that are time deposits (fixed-term) compared to total deposits.
Formula:Time Deposits to Total Deposits Ratio = (Time Deposits) ÷ (Total Deposits)
Why and When to Use:
Highlights deposit stability; time deposits are less volatile compared to demand deposits.
Useful during economic stress to gauge reliance on stable funding sources.
Example:If a bank has $10 billion in time deposits and $50 billion in total deposits, the ratio is 20%.
Time Deposits to Total Deposits Ratio in the Banking Sector
Reserve Ratio in the Banking Sector
The Reserve Ratio measures the proportion of a bank’s reserves (cash or liquid assets) held relative to its total deposits.
Formula:Reserve Ratio = (Reserves) ÷ (Total Deposits)
Why and When to Use:
Mandated by central banks to ensure liquidity and stability.
Higher ratios indicate better preparedness for sudden withdrawals.
Example:A bank with $1 billion in reserves and $20 billion in total deposits has a Reserve Ratio of 5%.
Reserve Ratio in the Banking Sector
Funding Gap Ratio in the Banking Sector
The Funding Gap Ratio compares the bank’s loans to its deposits, indicating reliance on external funding.
Formula:Funding Gap Ratio = (Net Loans) ÷ (Total Deposits)
Why and When to Use:
A ratio above 1 suggests reliance on external funding sources.
Useful for assessing funding risk and liquidity.
Example:If a bank has $15 billion in loans and $10 billion in deposits, the Funding Gap Ratio is 1.5.
Funding Gap Ratio in the Banking Sector
Spread to Prime Rate in the Banking Sector
This metric compares the bank’s loan rates to the prime lending rate to assess pricing strategy.
Formula:Spread to Prime Rate = (Average Loan Rate) — (Prime Rate)
Why and When to Use:
Indicates profitability of loan pricing.
Useful for evaluating competitiveness in lending.
Example:If the average loan rate is 7% and the prime rate is 5%, the spread is 2%.
Spread to Prime Rate in the Banking Sector
Gross Interest Yield in the Banking Sector
Gross Interest Yield measures the total interest income generated from interest-earning assets as a percentage of average interest-earning assets.
Formula:Gross Interest Yield = (Total Interest Income) ÷ (Average Interest-Earning Assets)
Why and When to Use:
Evaluates the profitability of a bank’s interest-earning assets.
Useful for tracking changes in asset yield due to interest rate movements or portfolio changes.
Example:If a bank earns $500 million in interest income from $10 billion in interest-earning assets, the Gross Interest Yield is 5%.
Gross Interest Yield in the Banking Sector
Non-Interest Expense to Average Assets Ratio
This ratio measures the efficiency of non-interest expenses relative to the bank’s average total assets.
Formula:Non-Interest Expense to Average Assets Ratio = (Non-Interest Expenses) ÷ (Average Total Assets)
Why and When to Use:
Indicates how well a bank manages its overhead relative to its size.
Lower ratios suggest higher operational efficiency.
Example:A bank with $200 million in non-interest expenses and $20 billion in average assets has a ratio of 1%.
Non-Interest Expense to Average Assets Ratio
Capital to Risk-Weighted Assets Ratio
This ratio compares a bank’s total capital to its risk-weighted assets.
Formula:Capital to Risk-Weighted Assets Ratio = (Total Capital) ÷ (Risk-Weighted Assets)
Why and When to Use:
Reflects a bank’s financial strength and its ability to absorb risks.
Required by Basel III regulations, often set at a minimum of 10.5% including buffers.
Example:If a bank has $2 billion in total capital and $25 billion in RWAs, its ratio is 8%.
Capital to Risk-Weighted Assets Ratio
Interest Rate Sensitivity Gap Ratio
This ratio measures the mismatch between rate-sensitive assets and liabilities within a given time frame.
Formula:Interest Rate Sensitivity Gap Ratio = (Rate-Sensitive Assets — Rate-Sensitive Liabilities) ÷ (Total Assets)
Why and When to Use:
Assesses exposure to interest rate risk.
Useful in understanding how interest rate changes impact net interest income.
Example:If rate-sensitive assets are $5 billion, liabilities are $4 billion, and total assets are $20 billion, the ratio is 5%.
Interest Rate Sensitivity Gap Ratio
Return on Risk-Weighted Assets (RoRWA)
RoRWA measures how effectively a bank generates profit from its risk-weighted assets.
Formula:RoRWA = (Net Income) ÷ (Risk-Weighted Assets)
Why and When to Use:
Indicates the bank’s ability to generate risk-adjusted returns.
Useful for comparing profitability across banks.
Example:If a bank earns $100 million in net income and has $1 billion in RWAs, its RoRWA is 10%.
Return on Risk-Weighted Assets (RoRWA)
Risk-Weighted Assets to Total Assets Ratio
This ratio shows the proportion of risk-weighted assets to total assets.
Formula:Risk-Weighted Assets to Total Assets Ratio = (Risk-Weighted Assets) ÷ (Total Assets)
Why and When to Use:
Indicates the relative riskiness of a bank’s asset portfolio.
Higher ratios suggest a more risk-weighted asset base.
Example:If a bank has $15 billion in RWAs and $20 billion in total assets, the ratio is 75%.
Risk-Weighted Assets to Total Assets Ratio
Cost of Funds in the Banking Sector
The Cost of Funds measures the average interest expense incurred on funding sources.
Formula:Cost of Funds = (Interest Expense) ÷ (Average Total Funding)
Why and When to Use:
Reflects the efficiency of managing funding costs.
Useful for assessing competitiveness in attracting deposits or debt financing.
Example:If a bank incurs $300 million in interest expense on $10 billion in funding, its Cost of Funds is 3%.
Cost of Funds in the Banking Sector
Net Interest Income (NII) to Total Income Ratio
This ratio measures the proportion of total income derived from net interest income.
Formula:Net Interest Income to Total Income Ratio = (Net Interest Income) ÷ (Total Income)
Why and When to Use:
Highlights reliance on interest income for overall profitability.
Useful for tracking income diversification trends.
Example:If a bank earns $600 million in NII and $1 billion in total income, the ratio is 60%.
Net Interest Income (NII) to Total Income Ratio
Net Fee Income Ratio in the Banking Sector
This ratio indicates the proportion of income derived from fees and commissions relative to total income.
Formula:Net Fee Income Ratio = (Net Fee Income) ÷ (Total Income)
Why and When to Use:
Reflects income diversification and reduced reliance on interest-based income.
Useful for banks focusing on fee-based services.
Example:If a bank earns $200 million in fee income and $1 billion in total income, the ratio is 20%.
Net Fee Income Ratio in the Banking Sector
Interest Expense to Total Deposits Ratio
This ratio measures the cost of deposits by calculating the interest expense incurred as a proportion of total deposits.
Formula:Interest Expense to Total Deposits Ratio = (Interest Expense) ÷ (Total Deposits)
Why and When to Use:
Indicates the efficiency of deposit cost management.
Useful for comparing funding costs across banks.
Example:If a bank incurs $50 million in interest expense on $10 billion in deposits, the ratio is 0.5%.
Interest Expense to Total Deposits Ratio
Operating Efficiency Ratio in the Banking Sector
The Operating Efficiency Ratio measures a bank’s operating expenses as a percentage of its operating income.
Formula:Operating Efficiency Ratio = (Operating Expenses) ÷ (Operating Income)
Why and When to Use:
Reflects how efficiently a bank manages its operations relative to its income.
A lower ratio indicates higher operational efficiency.
Useful for benchmarking cost management across banks.
Example:If a bank has $400 million in operating expenses and $1 billion in operating income, the ratio is 40%.
Operating Efficiency Ratio in the Banking Sector
Investment to Total Assets Ratio
This ratio measures the proportion of a bank’s total assets invested in securities or other financial instruments.
Formula:Investment to Total Assets Ratio = (Total Investments) ÷ (Total Assets)
Why and When to Use:
Indicates asset allocation strategy and reliance on investment income.
Useful for assessing liquidity and risk diversification.
Example:If a bank holds $5 billion in investments and has $20 billion in total assets, the ratio is 25%.
Investment to Total Assets Ratio
Yield on Loans
Yield on Loans measures the interest income generated from loans relative to the average loan balance.
Formula:Yield on Loans = (Interest Income from Loans) ÷ (Average Loan Portfolio)
Why and When to Use:
Assesses the profitability of a bank’s lending operations.
Useful for monitoring changes due to interest rate movements or loan pricing strategies.
Example:If a bank earns $300 million in interest income from loans and has an average loan portfolio of $10 billion, the yield is 3%.
Gross NPA and Net NPA Ratios in the Banking Sector
Gross NPA Ratio shows the proportion of non-performing assets (NPAs) to total loans. Net NPA Ratio accounts for provisions made.
Formulas:Gross NPA Ratio = (Gross NPAs) ÷ (Total Loans)Net NPA Ratio = (Gross NPAs — Provisions) ÷ (Total Loans)
Why and When to Use:
Indicates asset quality and credit risk.
Useful for assessing the effectiveness of provisioning policies.
Example:If a bank has $1 billion in gross NPAs, $200 million in provisions, and $20 billion in loans, the Gross NPA Ratio is 5%, and the Net NPA Ratio is 4%.
Gross NPA and Net NPA Ratio in the Banking Sector
Fee Income to Total Income Ratio
This ratio measures the contribution of fee income to total income.
Formula:Fee Income to Total Income Ratio = (Fee Income) ÷ (Total Income)
Why and When to Use:
Highlights the diversification of income sources.
A higher ratio indicates reduced reliance on interest income.
Example:If a bank earns $150 million in fee income and $1 billion in total income, the ratio is 15%.
Fee Income to Total Income Ratio
Deposits to Total Liabilities Ratio
This ratio shows the proportion of deposits in a bank’s total liabilities.
Formula:Deposits to Total Liabilities Ratio = (Total Deposits) ÷ (Total Liabilities)
Why and When to Use:
Indicates the stability and composition of a bank’s funding structure.
A higher ratio suggests a reliance on stable deposit funding.
Example:If a bank has $50 billion in deposits and $70 billion in liabilities, the ratio is 71.4%.
Deposits to Total Liabilities Ratio
Gross Loans to Total Assets Ratio
This ratio measures the proportion of a bank’s total assets allocated to loans.
Formula:Gross Loans to Total Assets Ratio = (Gross Loans) ÷ (Total Assets)
Why and When to Use:
Indicates asset allocation and lending focus.
Higher ratios suggest greater reliance on lending income.
Example:If a bank has $30 billion in loans and $50 billion in assets, the ratio is 60%.
Gross Loans to Total Assets Ratio
Interest Rate Risk (IRR) in the Banking Sector
Interest Rate Risk measures the potential impact of changes in interest rates on a bank’s earnings and economic value.
Formula:Interest Rate Risk = (Rate-Sensitive Assets — Rate-Sensitive Liabilities) ÷ (Total Assets)
Why and When to Use:
Critical for managing the bank’s exposure to interest rate volatility.
Useful in stress testing and scenario analysis.
Example:If rate-sensitive assets are $10 billion, liabilities are $8 billion, and total assets are $50 billion, the IRR is 4%.
Interest Rate Risk (IRR) in the Banking Sector
Net Charge-Off Ratio
This ratio measures the percentage of loans written off as a loss, net of recoveries, relative to average loans.
Formula:Net Charge-Off Ratio = (Net Charge-Offs) ÷ (Average Loans)
Why and When to Use:
Reflects the effectiveness of credit risk management.
Useful for tracking asset quality trends.
Example:If a bank charges off $50 million net of recoveries and has $10 billion in average loans, the ratio is 0.5%.
Non-Interest Income to Total Income Ratio
This ratio shows the contribution of non-interest income to total income.
Formula:Non-Interest Income to Total Income Ratio = (Non-Interest Income) ÷ (Total Income)
Why and When to Use:
Indicates diversification of income sources.
Useful for assessing income stability during volatile interest rate periods.
Example:If a bank earns $200 million in non-interest income and $1 billion in total income, the ratio is 20%.
Non-Interest Income to Total Income
Leverage Ratio in the Banking Sector
The Leverage Ratio measures the proportion of a bank’s core capital to its total exposure (including both on- and off-balance sheet exposures).
Formula:Leverage Ratio = (Tier 1 Capital) ÷ (Total Exposure)
Why and When to Use:
Reflects the bank’s capital adequacy relative to its total assets, serving as a backstop to the risk-based capital ratios.
Useful in determining how much risk a bank is taking relative to its capital.
Example:If a bank has $3 billion in Tier 1 capital and $30 billion in total exposure, the leverage ratio is 10%.
Leverage Ratio in the Banking Sector
Tier 1 Capital Ratio
The Tier 1 Capital Ratio compares a bank’s core capital (Tier 1 capital) to its risk-weighted assets.
Formula:Tier 1 Capital Ratio = (Tier 1 Capital) ÷ (Risk-Weighted Assets)
Why and When to Use:
It is a key measure of a bank’s financial strength and ability to withstand economic stress.
Tier 1 Capital includes equity capital and disclosed reserves, reflecting the ability to absorb losses.
Example:If a bank has $2 billion in Tier 1 capital and $20 billion in risk-weighted assets, the ratio is 10%.
Credit-to-GDP Ratio and Its Relevance in the Banking Sector
The Credit-to-GDP ratio compares the total amount of credit in the economy to the country’s GDP.
Formula:Credit-to-GDP Ratio = (Total Credit) ÷ (GDP)
Why and When to Use:
Indicates the level of credit relative to the size of the economy.
A high ratio may suggest an economy is overly reliant on debt, while a low ratio may indicate underdevelopment in credit markets.
It is useful for evaluating macroeconomic stability and financial system health.
Example:If the total credit in the economy is $1 trillion, and the GDP is $2 trillion, the Credit-to-GDP ratio is 50%.
Credit-to-GDP Ratio and Its Relevance in the Banking Sector
Net Interest Spread
The Net Interest Spread measures the difference between the interest income generated by a bank’s assets and the interest paid on its liabilities.
Formula:Net Interest Spread = (Average Yield on Assets) — (Average Cost of Funds)
Why and When to Use:
A key indicator of a bank’s profitability from its core lending operations.
A higher spread indicates a higher margin between borrowing and lending rates, which is a sign of profitability.
Example:If a bank’s average yield on assets is 6% and its cost of funds is 2%, the net interest spread is 4%.
Provision Coverage Ratio (PCR) in the Banking Sector
The Provision Coverage Ratio measures the adequacy of a bank’s provisions to cover potential loan losses.
Formula:Provision Coverage Ratio = (Provisions for Loan Losses) ÷ (Gross NPAs)
Why and When to Use:
A higher PCR indicates that the bank has made sufficient provisions to cover potential losses from NPAs.
Useful for assessing asset quality and credit risk management.
Example:If a bank has provisions of $500 million and gross NPAs of $1 billion, the PCR is 50%.
Provision Coverage Ratio (PCR) in the Banking Sector
Loan Loss Coverage Ratio
This ratio indicates the proportion of loan losses that are covered by provisions.
Formula:Loan Loss Coverage Ratio = (Loan Loss Provisions) ÷ (Non-Performing Loans)
Why and When to Use:
Reflects the bank’s ability to absorb loan losses with available provisions.
A higher ratio suggests that the bank is better prepared for defaults and losses.
Example:If a bank has $400 million in loan loss provisions and $800 million in non-performing loans, the loan loss coverage ratio is 50%.
Liquidity Coverage Ratio (LCR)
The Liquidity Coverage Ratio is a measure of a bank’s ability to withstand short-term liquidity disruptions by comparing liquid assets to net cash outflows over a 30-day period.
Formula:Liquidity Coverage Ratio = (High-Quality Liquid Assets) ÷ (Net Cash Outflows over 30 Days)
Why and When to Use:
Reflects the bank’s short-term liquidity position and ability to manage stress.
A minimum ratio of 100% is required under Basel III.
Example:If a bank has $2 billion in high-quality liquid assets and $1.5 billion in net cash outflows, the LCR is 133%.
Net Stable Funding Ratio (NSFR)
The NSFR measures a bank’s long-term liquidity risk by comparing available stable funding to required stable funding over a one-year horizon.
Formula:Net Stable Funding Ratio = (Available Stable Funding) ÷ (Required Stable Funding)
Why and When to Use:
Evaluates the long-term stability of a bank’s funding sources.
A ratio of 100% or higher is considered sufficient under Basel III.
Example:If a bank has $5 billion in available stable funding and $4 billion in required stable funding, the NSFR is 125%.
Net Stable Funding Ratio (NSFR)
Non-Performing Loans (NPL) Ratio
The Non-Performing Loans ratio measures the proportion of a bank’s total loans that are non-performing (i.e., loans that are overdue by a certain period, typically 90 days or more).
Formula:Non-Performing Loans Ratio = (Non-Performing Loans) ÷ (Total Loans)
Why and When to Use:
Indicates the quality of a bank’s loan book and potential future credit losses.
A higher NPL ratio signals increased credit risk.
Example:If a bank has $1 billion in NPLs and $20 billion in total loans, the NPL ratio is 5%.
Non-Performing Loans (NPL) Ratio
Capital Adequacy Ratio (CAR)
The Capital Adequacy Ratio measures a bank’s capital relative to its risk-weighted assets.
Formula:Capital Adequacy Ratio = (Total Capital) ÷ (Risk-Weighted Assets)
Why and When to Use:
CAR ensures that a bank has enough capital to cover potential losses from its operations and to absorb risks.
It is a regulatory requirement under Basel III, typically set at a minimum of 8%.
Example:If a bank has $4 billion in total capital and $50 billion in risk-weighted assets, the CAR is 8%.
Loan to Deposit Ratio (LDR)
The Loan to Deposit Ratio compares a bank’s total loans to its total deposits.
Formula:Loan to Deposit Ratio = (Total Loans) ÷ (Total Deposits)
Why and When to Use:
A high ratio indicates potential liquidity risks, as the bank may be lending out too much of its deposit base.
A low ratio suggests the bank is not fully utilizing its deposits.
Example:If a bank has $30 billion in loans and $40 billion in deposits, the LDR is 75%.
Cost to Income Ratio
The Cost to Income Ratio measures a bank’s operating expenses as a percentage of its operating income.
Formula:Cost to Income Ratio = (Operating Expenses) ÷ (Operating Income)
Why and When to Use:
Reflects the efficiency of a bank’s operations.
A lower ratio indicates better cost management and higher profitability.
Example:If a bank has $500 million in operating expenses and $1 billion in operating income, the cost-to-income ratio is 50%.
Net Interest Margin (NIM)
Net Interest Margin measures the difference between the interest income generated by a bank’s assets and the interest paid on its liabilities, relative to the average earning assets.
Formula:Net Interest Margin = (Net Interest Income) ÷ (Average Earning Assets)
Why and When to Use:
Reflects the profitability of a bank’s core lending activities.
A higher NIM indicates efficient asset-liability management and stronger profitability.
Example:If a bank has $400 million in net interest income and $10 billion in average earning assets, the NIM is 4%.