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Lecture Financial markets and institutions - Chapter 20: Bank performance includes the following content: Valuation of a commercial bank, performance evaluation of banks, risk evaluation of banks, how to evaluate a bank’s performance, bank failures. | Chapter 20 Bank Performance Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved. Chapter Outline Valuation of a commercial bank Performance evaluation of banks Risk evaluation of banks How to evaluate a bank’s performance Bank failures 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: Valuation of a Commercial Bank (cont’d) Factors that affect cash flows Change in economic growth During periods of strong economic growth: Loan demand is higher Commercial banks provide more loans Demand for other bank products tends to be higher Fewer loan defaults occur Expected cash flows should be higher 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 A high level of competition may reduce the bank’s volume of business or reduce the prices it can charge for its services Valuation of a Commercial Bank (cont’d) Factors that affect cash flows (cont’d) Change in management abilities Managers can attempt to make internal decisions that will capitalize on the external forces that the bank cannot control Skillful managers will recognize how to revise the composition of the bank’s assets and liabilities to capitalize on existing economic or regulatory conditions Valuation of a Commercial Bank (cont’d) Factors that affect the required rate of return by investors . | Chapter 20 Bank Performance Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved. Chapter Outline Valuation of a commercial bank Performance evaluation of banks Risk evaluation of banks How to evaluate a bank’s performance Bank failures 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: Valuation of a Commercial Bank (cont’d) Factors that affect cash flows Change in economic growth During periods of strong economic growth: Loan demand is higher Commercial banks provide more loans Demand for other bank products tends to be higher Fewer loan defaults occur Expected cash flows should be higher Valuation of a Commercial Bank (cont’d) Factors that affect cash flows (cont’d) Change in the risk-free interest rate If the
