Management of Return on Equity (ROE) of Banks

Ever wonder how to assess management style of a bank in a more quantitative way? A vision, an ability to grow and a long experience in the industry do not necessarily mean “good” management. As retail investors, besides meeting with the “friendly” board of directors during AGM and knowing them through news or autobiography, we should assess:

• how they use leveraging to impact return
• “Proof” of good management comes from strong performance throughout the cycle
• Risk management procedures and corporate governance need to be part of the culture.

One way to assess management of a bank is through the Dupont analysis of Return on Equity, aka Management of Return on Equity.

The Dupont analysis is common method to analyse growth drivers of common companies (non-banks). The Dupont analysis decomposes the different drivers of return on equity (ROE). The following are the videos that I made to explain the Dupont analysis for common companies.

We can apply the same concept on banks too, but the components in the Management of Return on Equity of banks is quite different from Return on Equity of normal companies.

Return on Equity = Return on Assets x Asset Leverage

NPAT / NW = NPAT / TA x TA / NW

• NPAT = Net profit after tax
• NW = Net worth (shareholders’ equity)
• TA = Total Assets

How do banks achieve a particular ROE target?

Below table shows management of ROE of top US banks where they achieved high ROE in 2021. To achieve this, management has choices about how much capital to hold.

Below table shows management of ROE of top Malaysia banks where they achieved high ROE in 2021.

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