Analyzing Bank Performance: Linking ROE, ROA and RAROC

Abstract

We introduce a new performance scheme for banks, inspired by the Du Pont scheme for corporates, which clarifies the relationship between return on equity (ROE), risk-adjusted return on capital (RAROC) and return on assets (ROA). The scheme highlights how common financial ratios as well as risk factors influence the development of ROA, RAROC and ROE. The scheme can be applied by managers, analysts and regulators to analyze the performance of an individual bank as well as the performance of the banking sector as a whole. In addition, it can be used by bank managers to set coherent targets for various key financial ratios that tend to be managed separately within a bank, to achieve a target ROE, RAROC and ROA. We illustrate our performance scheme by applying it to analyze the main drivers behind the development of the performance of the Swiss banking sector during the past 15 years.

Keywords: performance measurement, risk-adjusted performance, bank performance

JEL Classification: G21