Why bank health matters and how to assess it for your company's financial security

Bank operations and their driving impact on the economy

First, let's understand the basics of banking.

The primary activity of banks is to receive deposits from those with money and use these funds to lend to those in need of money. They pay interest on the deposits and earn a higher interest on the loans, which is a key source of income.

Another key banking function is payment processing. A seamless payment system is vital for smooth trade and economic growth.

Many banks provide special services to businesses, such as raising investments through debt and equity underwriting and facilitating mergers and acquisitions, for a fee, of course.

Banks also play a leading role in transmitting the government's monetary policy, which is central to achieving high economic growth while keeping inflation down and prices stable.

Banks have a driving impact on individuals, institutions, and the economy. For corporate leaders such as yourself, banks support business growth by providing commercial banking services, working capital loans, trade finance, insurance and other risk mitigation solutions, and enhanced financial management via digital transactions and automated payments. They also invest in infrastructure aimed at enhancing economic growth, which in turn benefits businesses by creating opportunities to expand, access resources, and improve their future prospects.

Why assess your bank's financial health

Banking services are essential for individuals and businesses to manage and protect their capital, invest wisely, and plan for the future.

Banks can power the economy of an entire city or country by providing loans and lines of credit and creating employment opportunities. They drive community development by supporting local businesses and initiatives. Many of them also work for the upliftment of specific communities.For example, by improving access to funds and other financial services for underprivileged groups and women.

When banks fail (which they do sometimes), it has far-reaching consequences not just for direct customers but for other banks, communities, and the market as well.

In today's competitive world, banks are committed to giving their customers the best digital tools, resources, knowledge, insights, guidance, and opportunities. On their part, millions of customers expect not just the latest products and services from their banks but perhaps more importantly, the ability to manage their funds and explore financial opportunities with confidence. Given that financial well-being has a direct impact on physical, mental, and social well-being, it is, therefore, necessary to assess your bank's financial health before leaving your hard-earned funds in its safekeeping. ¹

How to assess bank health

To assess the financial health of banks, you need to put their financial position, management practices, services, and commitment to consumers under a microscope. There are several financial metrics that serve as reliable indicators of bank financial health, including capital adequacy ratio (CAR), liquidity ratios, loan-to-deposit ratio, non-performing assets (NPAs), and net interest margin (NIM). Based on these indicators, ask yourself the following questions to gauge your bank's financial fitness:

1. Does your bank have sufficient capital?

Checking the capital adequacy ratio (CAR)—also called the capital-to-risk weighted assets ratio (CRAR)—gives you a fair idea of your bank's ability to cushion potential losses. It tells you how likely it is to fail and lose your deposit. Typically, a higher CAR reflects greater ability to absorb losses and stay solvent.

2. Does your bank have adequate liquidity?

To answer this question, you need to check its liquidity ratios. These tell you whether your bank has adequate liquid assets to cover unforeseen withdrawals. The higher the ratio, the better placed it is to deal with sudden withdrawals and short-term obligations. However, what constitutes a good liquidity ratio can depend on bank type, lending model, and overall strategy, so keep this in mind.

Another gauge of liquidity is the loan-to-deposit ratio, which measures the percentage of deposits a bank lends out at a given time. Typically, a high ratio indicates poor liquidity. This ratio, too, is subject to the same considerations as liquidity ratios.

3. Does your bank have high-quality assets?

A bank's assets primarily comprise loans made out to clients and investments in securities. This means monitoring the lending track record is important. A high proportion of NPAs or unpaid loans means assets are not in the best condition. Given that interest on loans is a major income generator, a high NPA score indicates poor financial health.

You might also want to check the provisioning coverage ratio (PCR), or funds reserved to cover losses from NPAs. A high PCR indicates a greater buffer against bad loans.

4. Does your bank have a track record of profitability?

Besides net income, there are several metrics you can use to evaluate profitability. The first is net income margin (NIM), or the difference between interest earned on loans and interest paid on deposits. A higher NIM indicates the bank is earning more interest than it is paying. But do remember, NIM is influenced by demand for loans, which in turn changes with shifts in monetary policy.

Then there's return on assets (ROA), which indicates a bank's profitability in relation to its total assets. It represents the per-dollar profit earned on assets (loans). The higher the ROA, the greater the profit.

Where to look for answers

The next step in evaluating a bank's financial health is knowing where to look for answers. Banking regulators access financial statements, including balance sheets, to assess profitability and stability. One can find information on loans and assets in mandatory filings to regulators such as the Federal Deposit Insurance Corporation (FDIC) in the US. ²

Known as call reports, these quarterly filings are intended to strengthen bank financial health and protect consumer rights. You can check the reports to see your bank's deposit insurance status. For example, Deposit insurance is a guarantee provided on deposits to secure them against bank failure. Call reports are open to use not just by bank authorities but by the public, researchers, and rating agencies, too.

In the spirit of transparency and disclosure, many financial institutions allow customers to access their financial statements, which benefits the evaluation process.

Regulators like the FDIC also periodically publish enforcement actions taken against banks for rule violations. ³ These reports provide direct insights into a bank's financial management practices and compliance record.

Furthermore, rating agencies regularly publish ratings of banks and credit unions. These ratings are yet another useful resource in performing bank assessments.

How to access banks' financial data in Singapore

Leading banks in Singapore regularly publish their balance sheets and other financial reports on their websites. You can find insights into their net interest margin, net profit, liquidity ratios, and loan-to-deposit ratio in these files.

In addition, the Monetary Authority of Singapore publishes enforcement and regulatory actions taken against banks and individuals. ⁴

We also advise you to check the Singapore Deposit Insurance Corporation (SDIC) website to ensure your bank is a member and, hence, covered by the deposit insurance scheme.

Then, there are leading credit rating agencies that assign ratings to banks in Singapore and publish credit profiles while also reporting on their profitability and stability. ⁵

Key considerations when measuring bank financial health

• You can consider these qualities – quality assets, profitability, robust risk management, high credit quality, high deposit insurance, low NPA proportion – to signal good banking health.
• At the same time, look for banks that prioritise innovation and transparency, embrace technology to stay competitive, and work actively to build investor trust.
• Check for ability to respond to change, challenges, and opportunities – which are critical in eliminating potential losses and ensuring consumers' financial health now and in the future.
• Finally, remember that banks' financial health is influenced by several other factors – the state of the economy, changes in regulations, tightening of monetary policy, technological disruptions, etc. Keep an eye on these external conditions as well.

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Frequently asked questions (FAQs)

How do you determine your bank's financial health?

When choosing a bank or moving forward with your existing bank, you must always determine its financial fitness. Monitoring its profitability, ability to maintain liquidity in the face of challenges, risk management practices, and commitment to transparency and regulatory compliance are the norm.

What are common indicators of bank financial health?

Capital adequacy ratio (CAR), liquidity ratios, loan-to-deposit ratio, non-performing assets (NPAs), and net interest margin (NIM) are key indicators of a bank's financial health and stability.

What are the risks of overlooking your bank's financial health?

Failing to monitor your bank can leave your assets unprotected and your financial well-being at risk. In the rare event of a bank failure, you could end up losing your deposit and investments if not insured, or have to wait for a payout or prepare to move to a new bank that has acquired the failed bank's assets.