By BankingMyWay.com Staff
Given the recent deluge of bank failures, many consumers are left wondering if their financial institutions are safe. The FDIC compiles a list of banks in trouble, but that list is not made available to the general public

Some independent analysts and financial research companies examine bank financials to evaluate relative bank safety. Here are some of the factors they consider.

Capital Adequacy

Financial institutions are often judged by how “capitalized” they are. This refers to how much capital a bank has in comparison to its asset risk. In determining the safety of a bank, it’s important to not only look at the numbers, but also to take a look into the numbers. Evaluating capital adequacy requires an examination of the composition and quality of tangible capital as well as capital growth potential. Bank capital functions as a safety net to protect depositors and investors against potential losses.

Regulatory agencies like the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board set capital requirements for banks. In order to qualify for FDIC insurance, most financial institutions must have a Tier 1 (primary) capital to asset ratio of not less than 4%. Some highly rated institutions may have a ratio of not less than 3%, however. Institutions with ratios below 3% are considered severely undercapitalized and unsafe.

Asset Quality

A financial institution’s assets are not all made equal. Some assets represent more risk than others. Consequently, it’s crucial to make qualitative assessment of the composition of a bank’s assets in order to get a true picture of its stability. This includes looking at loans, advances, investment securities and liquid assets. A bank’s loan book is highly scrutinized with a focus on non-performing loans. Changes to asset quality can greatly affect the safety evaluation of a financial institution. This has been demonstrated by the subprime mortgage collapse.

Profitability

A bank’s income statements for the current year as well as prior years are significant factors in judging the bank’s safety. To examine profitability, most analysts look at a variety of efficiency ratios, including interest margin (net interest:gross interest) and net interest margin (net interest:total interest earning assets). Non-interest income, operating expenses and bad debt charge are also compared to total operating income.

Liquidity

How much cash a bank has to meet long-term debt obligations is a big factor in judging bank stability as well as its capacity for growth. To evaluate liquidity, analysts look at a bank’s sources for funding and how these funds flow. A bank’s access to credit and the potential for asset liquidation is also examined.

Economic and Industry Risk

Evaluating the safety of a bank is not done in a vacuum. The overall environment a bank operates in must also be considered. The country’s current economic situation has great effects on the banking industry. The growth or contraction of the economy is an important factor as is the financial strength of private and public sectors related to the banking industry. In order to properly evaluate a bank’s access to capital, it is also important to consider the industry conditions including flow of funds through the banking system and the regulatory environment.

Market Position

Finally, a bank’s position within the economic and industry landscape is also an important consideration. Market share and core competence play large roles in a bank’s ability to weather market vulnerabilities. Management strategies including diversification of revenue and risk management, among others are also important.

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