How to Calculate Profitability Ratios for Banks

by Charlotte Johnson, studioD

In an economy that is ever-fluctuating, investors want to know that their money is safe. Since some banks have performed financial belly-flops, you may want to investigate a bank's profitability before you place your money in their care. Three primary measures of bank profitability are known as the "Return on Assets" (ROA) , "Return on Equity" (ROE) and the "Net Interest Margin" (NIM). Ratios are comparisons of various quantities. Use these formulas to determine the profitability ratio of a bank.

Return on Assets

Calculate the bank's net income. This is its total income (or "gross" income) minus its expenses such as provision for loan losses and non-interest expenses. For instance, if a bank has a gross income of $50 million and expenses totaling $8 million, you would subtract $8 million from $50 million to get a net income of $42 million.

Add the bank's assets, such as loans, securities and cash. For this example, assume that the bank has assets totaling $75 million.

Divide the bank's net income by its assets to find the Return on Assets. This is the ratio that you are comparing. In this example, you would divide $42 million by $75 million to get 0.56. To state this as a percent, multiply times 100, to equal 56 percent.

Return on Equity

Subtract the bank's expenses from its gross income to find the net income.

Divide the bank's net income by its capital. A bank's capital consists of items including the equity of shareholders, reserves and retained earnings. Consider an example in which a bank has $100 million in net income and $800 million in capital. Divide $100 million by $800 million to get 0.125.

Convert the ratio of income to assets to a percentage by multiplying your answer from step two times 100. In this example, you would multiply 0.125 times 100 to get 12.5 percent.

Net Interest Margin

Subtract the bank's interest expenses from its interest income. Consider an example in which a bank has $500,000 in interest income and $50,000 in interest expenses. Subtract 50,000 from 500,000 to get $450,000.

Divide your answer from Step 1 by the bank's assets. If the bank in this example has assets totaling $700,000, you would divide $450,000 by $700,000 to get 0.643.

Multiply the decimal form of this ratio by 100 to get the answer as a percentage. In this example, you would multiply 0.643 times 100 to get 64.3 percent.

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About the Author

Charlotte Johnson is a musician, teacher and writer with a master's degree in education. She has contributed to a variety of websites, specializing in health, education, the arts, home and garden, animals and parenting.

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