Net income which signifies the profits that a bank makes after taxes gives us a direct view of a bank’s performance in terms of its ability to pay dividends as well as retain earnings. However, the net income fails to adjust to the size of the bank and as such deprives evaluators of the ability to compare one bank to the other based on performance. That is why, it is necessary to use modern measures of measuring bank performance.
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To accommodate the adjustment to the size of the bank, the basic measure of performance that is used is the return on assets (ROA). The return on assets is calculated by dividing a bank’s net income by the amount of the assets owned by the bank (Mishkin & Eakins, 2012). The return on assets is a more realistic indicator of a bank’s performance as it shows how the assets can generate profits. The measure does have a limitation in which it does not indicate a bank’s profitability.
The return on equity (ROE) is the standard measure used to evaluate a bank’s profitability as desired by the bank equity holders. Mishkin and Eakins (2012), argue that a bank’s “return on equity indicates the net income per dollar of equity capital, providing a clear picture of the earnings on the investment” (p. 419).
Another modern measure of a bank’s performance includes a measure of the net interest margin (NIM). Mishkin and Eakins (2012), illustrate that the net interest margin gives the “percentage difference between the interest on the income versus the interest on the expenses and is presented as a percentage of the bank’s assets” (p. 420). Mishkin and Eakins (2012), also indicate that the net interest margin measures “the spread between the interest that a bank earns on its assets and the interest on its liabilities” (p. 420).
According to Mishkin and Eakins (2012), the regulators of the financial sector are faced with a myriad of challenges with the major one being the dynamism that signifies the financial sector. As such, the regulators are forced to keep redesigning the existing regulations to control the amount of risks that financial industry players are willing to take. According to Calomiris (2009), regulators also have to come up with means of identifying innovative ways which financial institutions apply to evade the regulations.
One of the innovative methods of avoiding regulation is the adoption of a multinational operations strategy (Mishkin & Eakins, 2012). Given the multicounty operation the financial institutions have the ability to transfer their businesses from one country to another. This move poses a challenge to the regulatory authority as they often lack the knowledge and ability to monitor institutions with foreign affiliates. The lack of clear demarcation regarding who has the primary authority to regulate the financial institutions further aggravates the problem.
Financial institutions that are regulated may use other subtle means such as lobbying politicians to intervene on their behalf so as to make the regulators not impose as many regulations as required. The institutions take advantage of the fact that there are multiple regulations aimed at negating the risk-taking nature of the financial institutions (Calomiris, 2009). The existences of multiple laws that are aimed at regulating the financial sector also open up the industry to unnecessary litigations that aim to prolong the discussions on the regulations. The delay in reaching an agreement as a result of the protracted court battles opens up loopholes that render the regulatory authorities less efficient (Mishkin & Eakins, 2012).
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Calomiris, C. (2009). Financial innovation, regulation and reform. Cato Journal, 29(1), 65-91.
Mishkin, F., & Eakins, S. (2012). Financial markets and institutions. Prentice Hall: New York.