Analyzing Bank Performance: Risk Propositions


The banking and financial institutions are under severe pressure these days. The globalization and networking of economies have resulted in a cascade effect on the stock market, economies, and of course the financial viability of many companies and institutions. Australia too has not been far from this cascading effect as its economy has also been affected by global cues. The sub-prime lending crisis which led to the credit crisis and debt write-offs started from the US and gradually spread off to other parts of the world. Since the majority of the banks and financial institutions have operations in many parts of the world, the crisis in one part was bound to have ripple effects on the other parts as well. The report on the Australian Mortgage Industry (Vol. 7, 2008), brought out by Fujitsu Consulting and JPMorgan points out some of the challenging circumstances that the banks and financial institutions may find themselves in if the crisis goes out of hand. At the same time, the report also points out the inherent strengths of the Australian financial system.

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Some of the features of the report are

  • It finds out the support of Australian households to the economy and mortgage market. The report indicates that from December 1992 to December 2007 the total system dynamic LVR has risen from 12.1% to 24.2%.
  • But the global credit crisis led to the decline in the proportion of all loans across the industry through brokers. It has declined to about 36% since the crisis began.
  • In the coming months, mortgage stress is projected to increase. By June 2008, the stress could become four times as compared to last year’s figures.
  • With increasing cases of write-offs being undertaken by the banks and financial institutions, the economy is bound to take a hit, if the government does not chip in with adequate system support.

When the Commonwealth Bank, the largest bank in Australia, came out with its results in February 2008, the stock prices of the majority of the Australian banks started declining, because the Commonwealth Bank’s results were found to be disappointing (Ingemarsson, 2008). The profitability of the banking sector has become the key concern under the circumstances. But the confidence expressed by the Reserve Bank of Australia in the banking system of the country sounds reassuring for the investors and the business community. At the same time, Governor Glenn Stevens emphasized that the banks must not look towards the government to bail them out of the crisis, and instead, they’ll have to be more cautious and avoid further risk taking while assuming that the liquidity is no longer a threat (Ingemarsson, 2008a).

Risk propositions

The banking system works under certain assumptions and risk propositions. The risks depend upon how the customer would behave, how the stock market would move, the profitability/ earning of the client companies, or the interest rates. The risk proposition further widens when the bank starts its operations on an international scale. The Australian banking system is quite a competitive one with big players like National Australia Bank (NAB, ANZ, Westpac, and Commonwealth Bank. In addition, several smaller players and non-banking financial institutions also play a crucial role in the country’s economy. All these institutions are facing the heat on the revenue earning front. The rate of interest has seen an unprecedented hike in recent years and it is at the highest level since 2001. The risk components of the banking system include;

Credit Risk

The risk associated with a bank’s asset loans is termed credit risk. Credit risk is measured by;

  1. The ratio of non-performing assets to total loans and leases
  2. Ratio of nonperforming assets to equity capital.
  3. Ratio of total loans to total deposits.
  4. Ratio of net charge-offs of loans to total loans and leases
  5. Ratio of annual provision for loan losses to total loans and leases or the equity capital.

ANZ has been managing the credit risk within the limits by dealing with creditworthy counterparties, setting credit limits on exposures to counterparties, and obtaining collateral where appropriate. NAB is also maintaining a strong focus on the quality of assets to take care of its credit risk. The ratio of gross non-accrual loans to total loans of NAB has registered significant improvement from 0.62% to 0.59% during the last five years.

Liquidity Risk

This risk arises when the bank is short of liquid cash and is not able to meet the customer’s needs when he wishes to withdraw his money. This risk can be measured in terms of:

  1. Ratio of purchased funds (like federal funds, securities, etc) to total assets
  2. Ratio of cash and due-from balances held at other depository institutions to total assets.
  3. Ratio of cash assets and government securities to total assets.

This figure becomes damaging when the liability figure outgrows and starts showing the signs of becoming more than the assets. As per the annual report, on 30th September 2007, ANZ had an asset amount totaling $m59030 for the next three months as against liabilities for the corresponding period of about $202556. But it has been able to manage that effectively for this period helps the bank in projecting encouraging figures for the next couple of years. For a period of 1 to 5 years, the bank had liquid assets of $m57183 as against the liabilities of $m51794. This figure would help the bank in retaining a good liquidity ratio in the coming months. Similarly, the total cash and liquid assets of NAB are $m6190 on September 30th, as against the corresponding figures of $m5913 for the year 2006.

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Capital Risk

This is the long-term survival risk of the bank. When the bank starts writing off the bad debts, the stock holder’s reaction puts the bank at capital risk. the investor might not like the idea of such write-offs. This type of risk is measured by;

  1. Interest rate spread between market yields on debts issues and the market yield on government securities of the same maturity.
  2. Ratio of stock prices per share to annual EPS (earnings per share).
  3. Ratio of equity capital (net worth) to total assets
  4. Ratio of purchased funds to total liabilities
  5. ratio of equity capital to risk assets.

Interest Rate Risk

The movement of interest rates affects the profitability of the bank. Therefore the risk can be measured in terms of i. The ratio of interest-sensitive assets to interest-sensitive liabilities ratio of uninsured deposits to total deposits.


These risks appear to be quite genuine and damaging for the health of the economy and banking institutions in Australia. The increased awareness on the part of the banking institutions on a resolute need to provision for setting off the impending crisis will help in taking on the risk. For example, the NAB has acknowledged in its FY 2007 report that the Group sold or transferred $12,300 million as again $4,771 million in FY 2006, of loans and advances through securitization or other arrangements which did not qualify for de-recognition from the balance sheet.

The report admits that it remains exposed to the risks like the liquidity risk, interest rate risk, and credit risk of the loans and advances (NAB, 2007). Similarly, the ANZ group also admits the risks but at the same time provisions the risk by setting up a credit protection mechanism that could allow the bank to sell the credit risk on portfolios (ANZ, 2007). The bank has total assets for less than three months at $m253,326 against the liabilities of $m246,992 for the corresponding period. This seems to suggest that the bank appears to be in a safe zone for the next couple of months. ANZ also uses a two-dimensional risk grading system to measures both the customer’s ability to repay (probability of default) and the loss in the event of default (a factor of the security taken to support the facilities). Therefore, from the discussion, it is quite apparent that while the risks associated are quite real, the Australian banks do not appear under extreme pressure to disappear from the scene. The upsurge in stock market indices in the first fortnight of April 2008 is a healthy indication towards stabilization of the crisis and global efforts are already on to contain the damage as soon as possible.


ANZ (2007). Annual Report. Web.

Ingemarsson, Petter (2008). Australian banks: pressured by increasing funding costs. Web.

Ingemarsson, Petter (2008a). Australian banking: RBA still confident about the financial system. Web.

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NAB (2007). Annual Report. Web.

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