Question

The recent financial crisis has shown how ROE failed to discriminate the best performing banks from the others in terms of sustainable profitability. Which of the following components of ROE would have provided at the time, a more reliable indicator(s) of assessing banks’ performance?

1. Margin (net income to operating revenue ratio).

2. Turnover (operating revenue to total assets ratio).

3. Leverage.

4. None of the answers.

5. All of the answers.

Public bailouts of banks are likely to:

1. Be a source of moral hazard.

2. Undermine market discipline (monitoring function).

3. Destabilise public finances and sovereign debt.

4. None of the answers.

5. All of the answers.

Answer 1

1. All of the answers

DuPont analysis allows trends underlying the change in RoE to be better analysed breaking down RoE into financial leverage (assets/equity), asset yield (operating revenue/assets) and profit margin (net income/operating revenue) to better assess bank's performance and profitability

2. All of the answers

Public bail-outs of banks are a source of moral hazard tend to undermine market discipline. Further, they may have a destabilizing impact on public finances and these concerns should result towards reforms which would help to the banks to internalize their cost of risks taken.