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Chapter 20
Bank Performance
Financial Markets and Institutions, 7e, Jeff Madura
Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.
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Chapter Outline

Valuation of a commercial bank

Performance evaluation of banks

Risk evaluation of banks

How to evaluate a bank’s performance

Bank failures
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Valuation of a Commercial Bank

The value of a commercial bank is the present
value of its future cash flows:

The value should change in response to
changes in its expected cash flows and to
changes in the required rate of return:
∑
=
+
=


Fewer loan defaults occur

Expected cash flows should be higher
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Valuation of a Commercial Bank
(cont’d)

Factors that affect cash flows (cont’d)

Change in the risk-free interest rate

If the risk-free rate decreases and other market rates decline, there
may be stronger demand for the bank’s loans

Banks’ cost of funds decreases when the risk-free rate decreases

Change in industry conditions

If regulators reduce the constraints imposed on commercial banks,
expected cash flows should increase

Technical innovation can improve efficiencies and enhance cash
flows


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Valuation of a Commercial Bank
(cont’d)

Factors that affect the required rate of return by
investors (cont’d)

Change in the risk premium

When the risk premium increases, so does the return required by
investors:

Impact of the September 11 Crisis on commercial bank
values

Commercial bank valuations declined as a result because
economic conditions were weakened and the volume of bank
loans declined
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