Part I – How Do We Analyze Banks?

banks SG


It is understandable that some investors might shun away from financial institutions such as banks as it gets a tricky to analyze these financial behemoths. However, for those who are interested investing in banks, here are some factors to look out for. Read on!


Banks play a pivotal role in an economy by providing credit to corporations. As mentioned in a previous article, Banks and the Multiplier Effect, banks act as an intermediary to supply capital from savers (through current and savings account) to borrowers while earning a spread called the net interest margin (NIM). As banks grow together with the economy, their revenue source diversifies from just lending to underwriting businesses. These fees and commissions earned from underwriting are derived from helping companies raise equity (IPO) or bonds in the capital markets and/or acting as a distribution platform selling financial products including insurance (bancassurance) and unit trusts (wealth management). Our 3 local banks, Oversea-Chinese Bank (OCBC) (SGX: O39) , Development Bank of Singapore (DBS) (SGX: D05)  and United Overseas Bank (UOB) (SGX: U11)  are already doing more than just commercial lending.  As investors, we want to focus on a bank’s balance sheet as it tells us how banks run their business.


Loans-to-deposit ratio

A commonly used ratio to measure a bank’s liquidity and its aggressiveness in credit lending. The loans-to-deposit ratio (LTD) measures the bank’s total loans relative to its total deposits derived from corporate and retail customers. If the LTD ratio is higher than 100%, the bank requires additional non-deposit funding (i.e. interbank borrowings or debt borrowings such as bonds) in order to support the loans it is lending out. An LTD ratio that is too low might suggest that banks may not be fully utilizing their deposits and still have the potential to ramp up lending organically. Some countries such as China places a cap on the LTD ratio (currently at 75%) on its banks in order to curb the country’s lending policy. Below is a quick calculation of the 3 local banks’ LTD ratio:


(SGD millions)

Total Loans Total Deposits Loan-to-Deposit Ratio
OCBC Bank (1Q2014) S$173,456 S$199,403 0.87x
DBS Bank (2Q2014) S$253,229 S$301,490 0.84x
UOB Bank (2Q2014) S$189,695 S$216,128 0.88x

Source: Company website and annual reports


From the table above, the 3 local banks have LTD ratio below 100% and are approximately 0.86x. This can be considered a prudent range as it allows room for liquidity. If these banks decide to increase lending where LTD > 100%, additional funding sources might be required.


Funding Source

A bank’s bloodline. It is critical to understand a bank’s sources of funding. Banks are highly leveraged because deposits are considered a form of liability to the financial institution. However, if a bank has difficulty attracting deposits, it has to turn to the interbank or bond markets to raise external funding. Such funding sources tend to be scarce in periods of crisis where liquidity is low. On the other hand, deposits tend to be more “sticky” despite their short-term nature (i.e. anyone can withdraw their deposits instantly) since depositors do not typically rush for large withdrawals despite a crisis. Debt issued and deposits & balances of banks make up the total external funding source as seen below:


(SGD millions) Total Liabilities % of External Funding Debts issued Deposits and balances of banks
OCBC Bank (1Q2014) S$314,608 15.1% S$25,571 S$22,093
DBS Bank (2Q2014) S$380,832 11.3% S$24,498 S$18,521
UOB Bank (2Q2014) S$268,694 15.8% S$24,060 S$18,362

Source: Company website and annual reports


From the table above, the 3 local banks do not rely extensively on non-deposit funding. If banks have to increase its reliance on external funding sources, they might have to pay a premium during times of crisis to sustain their lending business since the supply of interbank and debt funding declines.


Value in Action

The balance sheet should be the first thing to look at when analyzing a bank. It is critical to understand how much a bank has lent out credit in relation to its funding sources. In addition, a breakdown of the various funding sources would help investors understand better whether a bank has the liquidity to pull through an economic crisis.


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All views and opinions articulated in the article were expressed in Willie’s personal capacity and do not in any way represent those of his employer and other related entities. Willie does not own any shares in the companies mentioned above.


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