Key ratios for banks and insurers · RiskAtoms Academy

By the end you will be able to

1Calculate return on equity, the cost-income ratio, net interest margin and the loan-to-deposit ratio from a bank's accounts.
2Explain what each ratio tells a risk manager, and what pushes it up or down.
3Compare two banks on the same ratios, using the same conventions.
4Read the matching insurer ratios: combined ratio, return on equity and solvency ratio.

Why it matters

An annual report runs to hundreds of pages. Analysts and supervisors start with a handful of ratios that fit on one line. Four of them tell you how profitable, how efficient, how well paid for lending and how dependent on markets a bank is.

Core explanation

Four ratios, four questions

A ratio turns two figures from the accounts into one comparable number. Here are the four that matter most for a bank, worked out for Example Bank plc from L1.8.02 and L1.8.03.

Ratio	Question it answers	Example Bank plc
Return on equity	How much profit for its owners?	14.0%
Cost-income ratio	How efficient is it?	54.7%
Net interest margin	How well paid is its lending?	2.33%
Loan-to-deposit ratio	How much does it rely on markets for funding?	90.9%

Return on equity (ROE). ROE is profit divided by equity: £4,200m ÷ £30,000m = 14.0%. Shareholders compare it with their cost of equity, the return they need for the risk. But read it with care: L1.8.06 showed that leverage multiplies returns. A high ROE can mean a good bank, or a thinly capitalised one. Look at return on assets too: here 0.84%.

Cost-income ratio (CIR). Operating costs ÷ operating income: £8,200m ÷ £15,000m = 54.7%. The bank spends about 55p to earn each pound of income. Impairments are left out on purpose, so the ratio measures running efficiency, not credit quality.

Net interest margin (NIM). NII ÷ interest-earning assets: £10,500m ÷ £450,000m = 2.33%. It is the spread the bank earns on its whole interest-earning balance sheet. It moves with interest rates, competition for deposits and the mix of loans.

Loan-to-deposit ratio (LDR). Loans ÷ customer deposits: £300,000m ÷ £330,000m = 90.9%. Below 100%, deposits fund all the loans. Above 100%, the rest comes from wholesale markets, which can dry up.

Read ratios together, not alone

Use the same definitions for every bank you compare: they vary between reports.
Analysts usually divide by the average of opening and closing balances. This lesson uses year-end figures to keep the arithmetic short.
Add the cost of risk (impairments ÷ loans, 0.40% here) to see credit quality, which the CIR leaves out.

For insurers, the matching set is the combined ratio from L1.8.05 (95% for Example Insurance SE), return on equity (15%), and the solvency ratio from L1.8.06 (186%). Banks' NIM and LDR have no direct insurer equivalent.

Sort itWhich ratio would flag it?

0 / 4 right

Each item is a warning sign. Which of the four bank ratios would show it first?

Costs are rising faster than income.
Loans are growing fast, funded by short-term borrowing from other banks.
Savers are being offered higher rates, but mortgage rates are not rising.
Profit is small compared with the shareholders' money tied up in the bank.

The formal version

Each ratio is a percentage (see the Math Atom). The one worth deriving is ROE, because it splits into two parts that tell different stories:

\text{ROE} = \frac{\text{Profit}}{\text{Equity}}

\text{ROE} = \frac{\text{Profit}}{\text{Assets}} \times \frac{\text{Assets}}{\text{Equity}} = \text{ROA} \times \text{Leverage multiple}

The other three, in full:

\text{CIR} = \frac{\text{Operating costs}}{\text{Operating income}}, \quad \text{NIM} = \frac{\text{NII}}{\text{Interest-earning assets}}, \quad \text{LDR} = \frac{\text{Loans}}{\text{Deposits}}

Check for Example Bank plc: 0.84% × 16.67 = 14.0%.

Try it

Every lever below changes the balance sheet and the income statement together, just as in a real bank. Push loan growth to 20%: which ratios move, and which way? Then let 10% of deposits leave instead. Can you find a combination that raises ROE but leaves the bank more fragile?

Try itRatio lab: Example Bank plc

Change in average loan rate0bp

Basis points: 100bp = 1 percentage point.

Change in operating costs0%

Pay rises, a new IT system, or a cost-cutting plan.

Deposits that leave0%

Replaced with wholesale funding at 4.5%.

Loan growth0%

New loans funded with wholesale funding at 4.5%.

Return on equity

14.0%

Profit ÷ equity

Cost-income ratio

54.7%

Operating costs ÷ operating income

Net interest margin

2.33%

NII ÷ interest-earning assets

Loan-to-deposit ratio

90.9%

Loans ÷ customer deposits

Profit £4,200m · operating income £15,000m · wholesale funding £80,000m. Equity is held at its year-end level.

Worked example

Two banks, side by side

Example Bank Asia Ltd is a made-up Singapore bank, reporting in Singapore dollars. Last year: net interest income S$2,400m, fees S$600m, trading income S$200m, operating costs S$1,280m, impairments S$160m and tax S$300m. At year end it had equity of S$12,000m, interest-earning assets of S$110,000m, loans of S$75,000m and deposits of S$90,000m.

Four ratios for Example Bank Asia Ltd

Step 1 of 6

1
Profit first
Operating income S$2,400m + S$600m + S$200m = S$3,200m. Less costs and impairments: S$1,760m. Less tax: S$1,460m.

Ratios also move in a crisis. Run a deposit outflow through Example Bank plc's balance sheet and watch the loan-to-deposit ratio, and the ROE hit from selling securities in a hurry.

Interactive balance sheetExample Bank plc

£ billion, year end

Assets · £500.0bn

Liabilities and equity · £500.0bn

assets liabilities equityDashed outline: size before any shock.

Assets: what it owns

Total assets£500.0bn

Liabilities and equity: how it is funded

Liabilities
Wholesale funding£80.0bn
Equity

Total liabilities and equity£500.0bn

Cash and central bank reservesasset · 10.0% of total assets

Notes and coins, plus the bank's account at the central bank. The most liquid asset there is.

Risk to watch: Liquidity: this is what pays depositors who withdraw on a bad day.

Apply a shock

Deposit run0%

Share of customer deposits withdrawn. Paid from cash first, then by selling securities at a 10% fire-sale discount.

Loss charged to equity

£0.0bn

Equity

£30.0bn → £30.0bn

Share of equity lost

0.0%

Loan-to-deposit ratio

90.9%

Loans as a share of customer deposits.

Return on equity

14.0%

Profit after the shock ÷ equity. Ignores tax.

Regulatory lens · looking ahead

None of these four is a regulatory minimum, but supervisors track them closely. The European Banking Authority, for example, publishes ROE, the cost-income ratio and the loan-to-deposit ratio for EU banks in its regular Risk Dashboard. The formal liquidity rules, the Liquidity Coverage Ratio and the Net Stable Funding Ratio, go further than the LDR and come in later levels.

Sparks

SparkA warning sign hiding in plain sight

Before 2007, several banks that later failed or needed rescue, including Northern Rock, had lent far more than they held in customer deposits. Their loan-to-deposit ratios were well above 100%, the gap filled by wholesale and securitisation markets that shut in the crisis. The ratio is simple, and it worked.

SparkA falling cost-income ratio is not always efficiency

When interest rates rise, NII often jumps and the cost-income ratio falls, even if the bank has not cut a single cost. Look at whether costs themselves fell, or only the income they are divided by rose.

Key takeaways

ROE = profit ÷ equity. It equals return on assets × leverage, so check both parts.
Cost-income ratio = operating costs ÷ operating income. Lower is more efficient; impairments are left out.
Net interest margin = NII ÷ interest-earning assets: the spread on the whole balance sheet.
Loan-to-deposit ratio = loans ÷ deposits. Above 100% means reliance on wholesale funding.
For insurers, read the combined ratio, ROE and the solvency ratio together.
Compare banks only on the same definitions; analysts usually use average balances.

Reaction

Check what stuck

Question 1 · objective 1

A bank makes a profit of €900m on equity of €7500m. What is its return on equity, in %?

%

Question 2 · objective 1

A bank has operating costs of $1300m and operating income of $2000m. What is its cost-income ratio, in %?

%

Question 3 · objective 1

A bank has net interest income of £2200m and average interest-earning assets of £100,000m. What is its net interest margin, in %?

%

Question 4 · objective 2

A bank's loan-to-deposit ratio is 130%. What does that tell you?

AIt holds more deposits than loansBIts loans exceed its deposits, so it relies on wholesale funding for the restCIt is insolventDIts capital ratio is 130%

Question 5 · objective 3

Bank A has an ROE of 15% with equity of 4% of assets. Bank B has an ROE of 12% with equity of 8% of assets. Which statement is right?

ABank A is better run: its ROE is higherBBank A's higher ROE comes from leverage: its return on assets is only 0.60%, against 0.96% for Bank BCBoth banks are equally riskyDROE cannot be compared between banks

Glossary

Return on equity: Return on equity: profit for the year divided by shareholders' equity.
Return on assets: Return on assets: profit divided by total assets.
Cost of equity: The return shareholders expect for the risk of owning the shares.
Cost-income ratio: Cost-income ratio: operating expenses divided by operating income. Lower means more efficient.
Net interest margin: Net interest margin: net interest income divided by interest-earning assets.
Interest-earning assets: Assets that pay interest: loans, bonds and balances at the central bank.
Loan-to-deposit ratio: Loan-to-deposit ratio: customer loans divided by customer deposits.
Cost of risk: Impairments for the year divided by loans.

Deep Dives & Origins

Deep Dives

Saunders and Cornett, Financial Institutions Management: A Risk Management Approach (McGraw-Hill), the chapter on evaluating bank performance with ratio analysis. Intermediate.
Koller, Goedhart and Wessels, Valuation: Measuring and Managing the Value of Companies, 7th edition (Wiley, 2020), the chapter on valuing banks. Advanced.

Origins

European Banking Authority, Risk Dashboard and its methodological guide (quarterly).
House of Commons Treasury Committee, The run on the Rock, Fifth Report of Session 2007–08.

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