BEYOND ROE – HOW TO MEASURE BANK PERFORMANCE SEPTEMBER 2010
B E YO N D RO E – H OW TO M E A S U R EB an k p er f orman c eSEPTEMBER 2010a p p end i xto there p ort oneu B an k i n gstru c tures
BEYOND ROE – HOW TO MEASUREBANK PERFORMANCEAppendix to the report onEU banking structuresIn 2010 all ECBpublicationsfeature a motiftaken from the 500 banknote.S E P T E M B E R 2010
European Central Bank, 2010AddressKaiserstrasse 2960311 Frankfurt am MainGermanyPostal addressPostfach 16 03 1960066 Frankfurt am MainGermanyTelephone 49 69 1344 0Websitehttp://www.ecb.europa.euFax 49 69 1344 6000All rights reserved. Reproduction foreducational and non-commercial purposesis permitted provided that the source isacknowledged.ISBN 978-92-899-0322-6 (online)
CONTENTS1 EXECUTIVE SUMMARY2 WHAT IS PERFORMANCEMEASUREMENT? WHAT IS IT USED FOR?2.1 Definition and approachesto performance measurement2.2 The scope of performancemeasurement analysis andits reflection in metricsor models applied5ANNEXES1828337Approach, questionnaire,workshop participantsand respondentsQuestionnaireon performance measuresReferences373842113 WHAT IS WRONG WITH ROE?3.1 What did RoE tell us? Empiricalevidence from large banks’ RoEtrend and changes3.2 What drives RoE?3.3 Caveats to relying on RoE in theassessment of bank performance4 REFINEMENTS AND ISSUESTO CONSIDER151820264.1 Refinements in terms of scope264.2 Refinements in terms ofproperties of performance measures 2 85 ADDITIONAL FACTORSAND ALTERNATIVE MEASURESOF PERFORMANCE5.1 Why do business models matter?5.2 Economic capital models andstress test results are keyelements of a performancemeasurement framework5.3 Governance and performance:incentive schemes basedon value creation may havean effect on performance5.4 Governance and performance:disclosure and market discipline6 CONCLUSION: WHICH IS THE WAYFORWARD?303033343536ECBBeyond RoE – How to measure bank performanceSeptember 20103
1 EXECUTIVE SUMMARYWhat is an acceptable level of return on equity(RoE) for a bank? This question is likely to playa pivotal role in the post-crisis debate amongbanking executives, investors and regulators.Following the spectacular losses in the financialcrisis and the massive government intervention,there is little public support for banks returningRoE ratios of well above 20%, as these havemostly proved to be unsustainable.Recent events have shown that the most commonmeasure for a bank’s performance, i.e. RoE, isonly part of the story, as a good level of RoE mayeither reflect a good level of profitability or morelimited equity capital. In addition, although the“traditional” decomposition of the RoE measure(i.e. looking at banks’ operational performance,risk profile and leverage) may have been usefulto assess banks’ performance during benigntimes, this approach has clearly not provenadequate in an environment of much highervolatility – such as during the global financialcrisis, where RoE fluctuations have been causedentirely by operational performance, whichdoes not aid our understanding of the potentialtrade-off between risk and return in performance.This may actually explain why some of thehigh-RoE firms have performed particularlypoorly over the crisis, dragged down by a rapidleverage adjustment.Against this backdrop, there is obviously roomfor taking a step back from the rather consensualmarket valuation of performance throughRoE and carrying out a more comprehensiveassessment of banks’ performance.This sets the context for the current reportby the BSC that aims: (i) to analyse issuesrelating to bank performance measurementand to examine why the commonly used RoEmeasure may not be sufficient to characterisebanks’ performance; (ii) to look at what maybe missing in this type of approach; and (iii) toidentify potentially complementary approachesto RoE. The findings and conclusions in thisreport are based on information drawn from avariety of sources, including a review of the1 EXECUTIVESUMMARYacademic and practitioner publications on thetopic, an analysis of main RoE drivers on thebasis of a set of bank case studies, a workshopwith market participants, a survey of relevantpractices among nine market participants,and the expertise of supervisory authoritiesand central banks.The capacity to generate sustainable profitabilityis used in this report as a definition for describingbanks’ performance. Profitability is essentialfor a bank to maintain ongoing activity and forits investors to obtain fair returns; but it is alsocrucial for supervisors, as it guarantees moreresilient solvency ratios, even in the context ofa riskier business environment. Indeed, retainedearnings appear to be one of the most importantdrivers of Tier 1 ratios.The main drivers of banks’ profitability remainearnings, efficiency, risk-taking and leverage.Various stakeholders (e.g. depositors, debtor equity holders and managers) emphasisedifferent aspects of profitability. These viewsneed to be taken into account by marketparticipants (i.e. analysts, rating agencies,consultants and supervisors) when looking atways of measuring bank performance that meettheir needs. For this, each different group ofmarket participants has its own preferred set ofindicators.In order to “demystify” RoE, the report detailsthe misconceptions and limitations of its useon the basis of case studies differentiatingbetween banks driven largely by investmentactivities and banks driven largely by traditionaldeposit-lending activities.The analysis points to an initial limitationof RoE, namely that it is not risk-sensitive.A decomposition of RoE shows that a riskcomponent represented by leverage canboost RoE in a substantial manner. Other riskelements, on the other hand, are missing in theRoE figure (e.g. the proportion of risky assetsand the solvency situation). RoE is thereforenot a stand-alone performance measure,ECBBeyond RoE – How to measure bank performanceSeptember 20105
and decomposition or further information isnecessary to identify the origin of developmentsand possible distortions over time.The recent crisis has shown how RoE failed todiscriminate the best performing banks from theothers in terms of sustainability of their results.RoE is a short-term indicator and must beinterpreted as a snapshot of the current health ofinstitutions. It does not take into account eitherinstitution’s long-term strategy or the long-termdamages caused by the crisis. Its weaknessesare even more obvious in times of stress, whenthere is a climate of uncertainty surrounding themedium-term profitability of institutions.In challenging times, extraordinary elements maybecome very significant, but fail to appear inreported RoE measures. As a matter of fact, RoEdoes not reflect the sustainable performance ofthe bank, if the change comes from a one-shotelement that cannot be reproduced in the future.RoE from continuing operations proves to bemore relevant for comparing institutions andassessing operating performance accurately.RoE measures more generally fail to take intoaccount measures with a long-term impact(e.g. restructurings and consolidation), therebyposing an additional challenge to performanceanalysis.Finally, RoE measures can be misleading, bemanipulated or provide wrong incentives asthey are influenced by quite strong seasonalfactors, rely on data and expose banks to higherunexpected risk levels.In order to come up with a more “informed”assessment of banks’ performance, RoE mustbe refined. In particular, desirable featuresof banks’ performance measures may covercomparability, stability over time and thecapacity to be forward-looking as well. In thatcontext, complementary measures to RoE, suchas risk returns, funding capacity, assets and ownfunds quality, cost of equity and capital allocationacross business lines may be of some help.Alternative approaches to measuring banks’performance may require a deeper analysisof the way in which banks run their businessand make use of their stress-testing results, oreven further enhancement of their high-leveldiscussions with supervisors on consistencybetween performance and business strategy.This may eventually call for more transparencyfrom banks on their profitability structure, andsome adjustment in the governance process,as suggested in the proposals for enhancingBasel II. Among other things, these measurescomprise a reassessment of the risk function withrespect to its independence and the availabletools and an adequate level of risk awareness atthe top-tier management level. As a result, theremay be some opportunity here for regulators toaddress these issues with bank managers.To summarise, the main messages of thisanalytical work are as follows:1. RoE may be less of a performance benchmark than a communication tool in the relationshipbetween banks and markets.2. A comprehensive performance analysis framework needs to go beyond that kind of indicator –though not excluding it – and provide for a more “informed” assessment, using banks’business-based data and qualitative information.3. The consistency of risk appetite with the business structure and strategy appears to be oneof the most crucial elements in assessing an institution’s capacity to deliver performance inthe future. Against this backdrop, sustainable indicators constructed on the basis of economiccapital models and financial planning frameworks inside the banks may become even more6ECBBeyond RoE – How to measure bank performanceSeptember 2010
1 EXECUTIVESUMMARYrelevant. For instance, risk-adjusted types of returns indicators, such as RAROC, may benefitfrom higher disclosure and better explanation to the markets, or at least to the supervisors.4. Desirable features for banks’ performance measures should encompass more aspects of theperformance than just profitability embedded in a pure market-oriented indicator such as RoE.In particular, it may be useful to take account of the quality of assets, the funding capacityand the risk associated with the production of value. In that context, a good performancemeasurement framework should incorporate more forward-looking indicators and be lessprone to manipulation from the markets.5. In the context of achieving a comprehensive analysis for all business areas, data availabilityand comparability are key factors. This may call for enhanced disclosure (both towards thesupervisors and, where possible, towards the public) and improved market discipline.6. As regards governance, the adoption of a more comprehensive and more forward-lookingassessment of performance may be a first step towards intensifying the dialogue with thebanks’ top-tier of management, related to the coherence between economic performance,business model and supervisory and financial stability issues.The report adopts the following structure:Chapter 2 starts by setting the context formeasuring bank performance: bank performanceis defined and the main drivers of profitabilityare outlined. In particular, this chapter identifiesthe different angles under which performancemeasurement can be approached. Chapter 3illustrates, on the basis of empirical evidence,the misconceptions and limitations of RoEmeasures. Chapter 4 outlines the report’ssuggestions for refinements in both scope andproperties of performance measurement, andaddresses issues to consider when applyingit. Chapter 5 elaborates on various additionalfactors and alternative ways of measuringperformance, before Chapter 6 concludes.ECBBeyond RoE – How to measure bank performanceSeptember 20107
2 WHAT IS PERFORMANCE MEASUREMENT?WHAT IS IT USED FOR?2.1 DEFINITION AND APPROACHESTO PERFORMANCE MEASUREMENTThis report analyses bank performance in terms ofits capacity to generate sustainable profitability.Profitability is a bank’s first line of defenceagainst unexpected losses, as it strengthens itscapital position and improves future profitabilitythrough the investment of retained earnings.An institution that persistently makes a losswill ultimately deplete its capital base, whichin turn puts equity and debt holders at risk.Moreover, since the ultimate purpose of anyprofit-seeking organisation is to preserve andcreate wealth for its owners, the bank’s return onequity (RoE) needs to be greater than its cost ofequity in order to create shareholder value.Although banking institutions have becomeincreasingly complex, the key drivers of theirperformance remain earnings, efficiency,risk-taking and leverage. In detail: while it isclear that a bank must be able to generate“earnings”, it is also important to take account ofthe composition and volatility of those earnings.“Efficiency” refers to the bank’s ability togenerate revenue from a given amount of assetsand to make profit from a given source of income.“Risk-taking” is reflected in the necessaryadjustments to earnings for the undertaken risksto generate them (e.g. credit-risk cost over thecycle). “Leverage” might improve results in theupswing – in the way it functions as a multiplier –but, conversely, it can also make it more likelyfor a bank to fail, due to rare, unexpected losses.There are a multitude of measures used toassess bank performance, with each group ofstakeholders having its own focus of interest.Box 1 gives an indicative, but non-exhaustivelist of indicators commonly used to measurebank performance.Box 1AN OVERVIEW OF PERFORMANCE MEASURES FOR FINANCIAL INSTITUTIONSAmong the large set of performance measures for banks used by academics and practitionersalike, a distinction can be made between traditional, economic and market-based measures ofperformance.Traditional measures of performanceTraditional performance measures are similar to those applied in other industries, with returnon assets (RoA), return on equity (RoE) or cost-to-income ratio being the most widely used.In addition, given the importance of the intermediation function for banks, net interest margin istypically monitored.The return on assets (RoA) is the net income for the year divided by total assets, usually theaverage value over the year.return on assets net income / average total assetsRoE is an internal performance measure of shareholder value, and it is by far the most popularmeasure of performance, since: (i) it proposes a direct assessment of the financial return of ashareholder’s investment; (ii) it is easily available for analysts, only relying upon publicinformation; and (iii) it allows for comparison between different companies or different sectors8ECBBeyond RoE – How to measure bank performanceSeptember 2010
2 WHAT ISPERFORMANCEMEASUREMENT?WHAT IS ITUSED FOR?of the economy. RoE is sometimes decomposed into separate drivers: this is called the “Dupontanalysis”, where RoE (result/turnover)*(turnover/total assets)*(total assets/equity). The firstelement is the net profit margin and the last corresponds to the financial leverage multiplier.return on equity net income / average total equityThe cost-to-income ratios shows the ability of the institution to generate profits from a givenrevenue stream. Impairment charges are not included in the numerator.cost-to-income ratio operating expenses / operating revenuesFinally, the net interest margin is a proxy for the income generation capacity of the intermediationfunction of banks.net interest margin net interest income / assets (or interest-bearing assets)Economic measures of performanceThe economic measures of performance take into account the development of shareholder valuecreation and aim at assessing, for any given fiscal year, the economic results generated by acompany from its economic assets (as part of its balance sheet). These measures mainly focuson efficiency as a central element of performance, but generally have high levels of informationrequirements.Two sets of indicators can then be identified amongst economic measures of performance:1) Indicators related to the total return of an investment, based on the concept of an“opportunity cost”; the most popular one being economic value added (EVA).EVA return on invested funds – (weighted average cost of capital * invested capital)– (weighted average cost of debt * net debt)(Developed by Stern and Stewart in 1991, EVA takes into account the opportunity cost forstockholders to hold equity in a bank, measuring whether a company generates an economicrate of return higher than the cost of invested capital in order to increase the market value ofthe company.)2) Indicators related to the underlying level of risk associated with banks’ activity. Accordingto Kimball (1998), for a bank to be successful in its operations, managers must weighcomplex trade-offs between growth, return and risk, favouring the adoption of risk-adjustedmetrics.RAROC (risk-adjusted return on capital, i.e. the expected result over economic capital) allowsbanks to allocate capital to individual business units according to their individual businessrisk. As a performance evaluation tool, it then assigns capital to business units based on theiranticipated economic value added.11 There are many different measures and different types of indicators under the generic name of RAROC: RORAA (return onrisk-adjusted assets), RAROA (risk-adjusted return on assets), RORAC (return on risk-adjusted capital).ECBBeyond RoE – How to measure bank performanceSeptember 20109
The theoretical RAROC can be extracted from the one-factor CAPM as the excess return on themarket per unit of market risk (the market price of risk).This measure shares in common with the EVA that it takes into account the bank’s cost ofcapital. But RAROC goes further because it adjusts the value-added in relation to the capitalneeded. However, literature is quite critical of this measure as a tool to analyse performance,essentially due to its thorough accounting basis 2, while it is then difficult to calculate RAROCwithout having access to internal data. Furthermore, it appears that RAROC may be appropriatefor activities with robust techniques for measuring statistical risk, such as credit activity. On thecontrary it may be less relevant for market activities, given that the value-at-risk (VaR) is still avery imperfect measurement of risk.Market-based measures of performanceMarket-based measures of performance characterise the way the capital markets value the activityof any given company, compared with its estimated accounting or economic value. The mostcommonly used metrics include: the “total share return” (TSR), the ratio of dividends and increase of the stock value over themarket stock price; the “price-earnings ratio” (P/E), a ratio of the financial results of the company over its shareprice; the “price-to-book value” (P/B), which relates the market value of stockholders’ equity to itsbook value; the “credit default swap” (CDS), which is the cost of insuring an unsecured bond of theinstitution for a given time period.2 See, for example, Weissenrieder, F. (1997) and Fernandez, P. (2002).Inevitably, different stakeholders in a bank viewperformance from different angles. For example,depositors are interested in a bank’s long-termability to look after their savings; their interestsare safeguarded by supervisory authorities. Debtholders, on the other hand, look at how a bankis able to repay its obligations; a concern takenup by rating agencies. Equity holders, for theirpart, focus on profit generation, i.e. on ensuringa future return on their current holding. Thisfocus is reflected in the valuation approachesof banks’ analysts, who try to identify the10ECBBeyond RoE – How to measure bank performanceSeptember 2010fundamental value of the firm. Managers,too, seek profit generation, but are subject toprincipal-agent considerations and need to takeemployee requests into consideration. The viewof bank consultancies might also encompass theinternal struggle of managers.This report encompasses a broad range of viewsdrawn from a variety of sources. It includes areview of the literature on the topic, examinesrelated case studies, assesses the conclusions ofa workshop held with market participants and
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posing an additional challenge to performance analysis. Finally, RoE measures can be misleading, be manipulated or provide wrong incentives as they are infl uenced by quite strong seasonal factors, rely on data and expose banks to higher unexpected risk levels. In order to come up with a more “informed” assessment of banks’ performance, RoE must be refi ned. In particular, desirable .
ROE-0505S 10µF 100V MLCC 22µH choke RLS-226 330pF 330pF ROE-0515S ROE-1205S ROE-2405S MODEL C1 L1 C2 (safety) C3 (safety) ROE-0505S 6.8µF, MLCC N/A N/A N/A ROE-0515S 4.7µF, MLCC N/A ROE-1205S 10µF 100V MLCC 470pF ROE-2405S N/A Notes: Note6: Filter suggestions are valid for indicated part numbers only.
Complaint, MISO TOs had a base ROE of 12.38% (except for the ATCLLC zone which had a 12.20% ROE),19 and their total ROE (i.e., the base ROE plus any ROE adders 17 The complainants consist of a group of large industrial customers: Association of Businesses Advocating Tariff Equity
Return on equity ROE Retention rate (including new equity) P Number of years in which spread is maintained N Equity growth g P x ROE Size of spread ROE - k E Market value of the firm shares . An M/B-vs.-Spread Graph for the 30 Dow Jones Industrials (1980)-8 X BS GT HR Z OI AC JM IP S UK T GM AA WX TX N GF UTX DD AMB
If the ROE is not returned within 90 days, the annuity account will be suspended. Please read the instructions on the form to make sure it is completed correctly. Sign and date the ROE and send it to Defense Finance and Accounting Service, U.S. Military Annuitant Pay, P.O. Box 7131, London, KY 40742-7131. ROE FOR INCAPACITATED ANNUITANTS:
ROE V. WADE WAS ABOUT MORE THAN ABORTION, New York Times, January 21, 2018 . WHEN ROE V. WADE MEANT MORE THAN JUST ABORTION RIGHTS, Washington Post, Jan. 22, 2018 . OHIO’S NEW ABORTION LAW IS AN ASSAULT ON ROE. HERE’S WHY IT WON’T WORK, Washington Post, December 9, 2016 . WHERE THE PRO-LIFE MOVEMENT GOES NEXT, New York Times, July
BV0 *ROE*Payout Ratio *(1 gn) r-g n P0 BV 0 PBV ROE*Payout Ratio *(1 gn) r-g n P0 BV 0 PBV ROE*Payout Ratio r-g n. 5! Price&Book&Value&Rao:&Stable&Growth&Firm& Another&Presentaon& Aswath Damodaran! 5!! & relang&growth&to&the&return&on&equity:&
level in the United States, Roe v Wade and its companion, Doe v Bolton, ‘were only two of approximately fifteen to twenty roughly simultaneous cases’ percolating through the courts at the time. When the Supreme Court heard Roe v Wade and Doe v Bolton, approxima
the instructional use of small groups so that students work together to maximize their own and each other's learning. It may be contrasted with competitive (students work against each other to achieve an academic goal such as a grade of "A" that only one or a few students can attain) and individualistic (students work by themselves to accomplish learning goals unrelated to those of the other .
