Introduction to the Armenian Banking Sector – Banks’ Performance Indicators

Return on Assets

The performance indicator Return on Assets (ROA) is an indicator of how profitable a bank is relative to its total assets. The ROA measures the management’s efficiency and informs about its ability to turn assets into earnings. For the year ending 2015, the ROA for the Armenian banking sector was 0.53% while in the year 2014, the figure was 5.7%. A high ROA is a telltale sign of solid financial and operational performance and given the sharp decline in ROA of 4.13%, this could give a possible insight on the decline in financial and operational performance of the Armenian banking sector for the year ending 2015. This also tells us that in 2015, the Armenian banking sector earned less than 1% profit on assets owned.

Return on Equity

The performance indicator Return on Equity (ROE) is the amount of net income returned as a percentage of shareholders equity and measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested. For the year ending 2015, the ROE for the Armenian banking sector was 3.50% while the ROE was 0.9% in 2014. Comparing the years 2014 to 2015, there has been an increase in equity of the Armenian banking sector. Since equity is the denominator in calculating ROE, an increase in ROE given that there is an increase in equity implies that there is a decrease in the net income of the sector.

Cost to Income Ratio

The cost-to-income ratio is a key financial measure, particularly important in valuing banks. By definition, it shows a company’s costs in relation to its income. Hence, in this case, it shows the banks’ costs in relation to the income earned by the banks.  The ratio gives investors a clear view of how efficiently the bank is being run where a lower cost-to-income ratio would imply that a higher bank profitability. Holding this in perspective, the cost-to-income ratio for the year 2015 for the Armenian banking sector was 63.3% while for the year ending 2014, the figure was a reported 54.4%. This could thus possibly suggest that costs are rising at a higher rate than income.

Capital Adequacy Ratio

The capital adequacy ratio (CAR) is a measure of a bank’s capital. The CAR is imposed by the central bank and this ratio is expressed as a percentage of a bank’s risk weighted credit exposures. It shows the bank’s ability to deal with different risks, such as credit risk or operational risk. The bank’s capital can be seen as a security for potential losses and is defined by banking regulators to protect depositors and other lenders. The main objective is to promote the stability and efficiency of financial systems around the world.

For the year ending 2014, the CAR of the Armenian banking sector was 14.5%. The CAR sets the amount of its own money a bank needs relative to its total loan portfolio. The loans’ riskiness is measured in percent. It is valid: The higher the percentage, the riskier the loan. This is the reason why banks are required to have a low CAR. The minimum acceptable ratio is 8%, which means that the Armenian banking sector fulfils the requirements. In 2015 the CAR increased by 1,7% to 16,2%. It shows that the Armenian banks are prepared and able to deal with different risks.

Profit Margin

The net profit margin ratio is a key performance indicator of the profitability of a bank. The profit margin is calculated as net income divided by revenue, or net profits divided by sales. The net income or net profit is equal to total income minus total expenses during a period, including operating costs, material costs and tax costs. Profit margins are expressed as a percentage and, in effect, measure how much out of every dollar of sales a company actually keeps in earnings. It is important that a bank’s earnings increase in the same relation or even more than its expenditures. Otherwise the profit margin will decrease.

At the end of 2014 the profit margin for the Armenian banking system was 4,8 %, which means that every $1 sale contributes 0,048 cents towards the net profits of the business. In 2015 the profit margin increased from 4,8 % up to 7,7%. It shows that the profit relative to the revenue earned was higher than in 2014.

However, a profit margin of 4,8 % or 7,7% is a low profit margin and in general it shows that a bank’s profitability is not very secure. In order to be able to make an exact statement and to identify performance gaps, the profit margin for the Armenian banking system has to be compared with other banking systems. If the profit margin is lower than other banking sectors it shows that other banks perform more efficient and that the Armenian banks have to improve their profitability of business in the future.

Operation Efficiency (Overhead Cost)

Operational efficiency is a bank’s capability to deliver products or services to its customers in the most cost-effective manner possible while still ensuring the high quality of its products, service and support.

Hence, measuring a bank’s operational efficiency means to measure its efficiency (‘doing things right’) and effectiveness (‘doing the right thing’). It has to be investigated how efficient a bank is in utilizing its input to produce its outputs. Therefore, a bank has to be compared with its competitors. If a bank is less efficient than other banks, it may does not use the right mix of inputs or producing the right mix of outputs given prevailing prices. In any case a bank only operates efficiently when it is able to cover its overhead cost. Overhead cost must be paid for on an ongoing basis, regardless of whether a bank is doing a high or low volume of business. It is important for determining how much a bank must charge for its products or services to make a profit.

At the end of 2015 the operational efficiency of the Armenian banking sector was 78,83 %.

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