Do Efficient Institutions Score Well Using Ratio Analysis? an Examination of Commercial Banks in the 1990s

By Lacewell, Stephen K. | Journal of Commercial Banking and Finance, Annual 2003 | Go to article overview

Do Efficient Institutions Score Well Using Ratio Analysis? an Examination of Commercial Banks in the 1990s


Lacewell, Stephen K., Journal of Commercial Banking and Finance


ABSTRACT

Commercial banks operating in today's economic system are a far cry from the financial institutions of earlier decades. The traditional definition of a bank as defined by Rose (2002) is "a financial intermediary accepting deposits and granting loans", which at first glance seems fairly mundane. However, modern banks are becoming increasingly technical in both scale and scope. Coupled with the ever-changing landscape of banking is the undeniable fact that for our financial system to remain productive it must be characterized by the virtues of strength and stability. This requires a competent and progressive regulatory system that is accurately able to determine the performance of financial institutions.

Although there is arguably no one correct measure of bank performance, the area of performance measurement can be divided into two rather large streams of research: bank efficiency measures and accounting-based financial ratios. The various statistical methods for measuring bank efficiency are rather new compared to traditional ratio analysis. However, various efficiency techniques are increasingly mentioned in academic studies as a complement to, or substitute for, financial ratio analysis which constitutes such a large portion of the CAMELS rating system utilized by financial institution regulatory agencies in their determination of a firm's safety and soundness.

This paper seeks to determine if the financial ratios and efficiency scores of banks provide much of the same information. That is, do banks with strong ratios also exhibit strong efficiency scores? This is accomplished in a three-stage process. Stage one is the calculation of both alternative profit efficiency scores and cost efficiency scores, using the stochastic frontier approach (SFA), for all banks operating in the United States during the years 1996 and 1999. This model is termed the national model per Mester (1997) due to the fact that all banks, for which sufficient data are available, are used to estimate the desired efficient frontier. Stage two involves the formulation of financial ratios that are, according to previous research, highly correlated with each of the CAMELS rating components. The final stage is the comparison of the results of the first two stages when the population of banks is segmented into thirds, consisting of high, medium, and low performing banks.

As mentioned earlier many studies have proposed the addition of some form of efficiency measure to the current CAMELS rating. With this in mind it is hypothesized that banks which score high using financial ratios will also tend to perform well using more complicated efficiency techniques. The results of this study will be of interest to many parties due to the fact that determining a correct measure of bank performance must take into account the high degree of competitiveness, technical change, customer-base diversity, and other areas of the firm's operating environment.

The findings show that there is a high degree of consistency between banks with strong financial ratios and banks that are rated highly efficient. This is consistent with previous studies by Yeh (1996) and Siems and Barr (1998). The major exception to this claim is found in the profitability ratios category, which is also consistent with Yeh (1996). This result, however, highlights the fact that the more technical efficiency estimation techniques may interpret data in a different manner than researchers and practitioner using traditional financial ratios.

INTRODUCTION

Commercial banks operating in today's economic system are a far cry from the financial institutions of earlier decades. The traditional definition of a bank as defined by Rose (2002) is "a financial intermediary accepting deposits and granting loans", which at first glance seems fairly mundane. However, modern banks are becoming increasingly technical in both scale and scope. Coupled with the ever-changing landscape of banking is the undeniable fact that for our financial system to remain productive it must be characterized by the virtues of strength and stability.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Do Efficient Institutions Score Well Using Ratio Analysis? an Examination of Commercial Banks in the 1990s
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.