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YouControl method of financial scoring of banks

YouControl’s method
фінансового скорингу банків
від YouControl

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Financial scoring of banks - the system of assessing the bank financial reliability by transferring of pre-calculated financial indicators to scores. The result of YouControl financial scoring of banks is the composite index Bank_FinScore.

Bank_FinScore Bank_FinScore is a bank financial reliability scoring index calculated by the YouControl analytical department based on 25 indicators, including NBU standards and financial ratios, which comprehensively reflect the state of liquidity, capital adequacy, profitability, credit, investment and currency risks of the bank. Since the index is used primarily for comparison with competitors in the Ukrainian market, it is not sensitive to system-wide changes. The index reflects the financial position of the bank relative to others in the sector.

The Bank_FinScore index value can vary in the range from 1 (minimum financial reliability) to 4 (maximum financial reliability), depending on the values of standards and financial indicators of the bank.

The components of the index were selected as a result of an empirical study of the dynamics of about 50 traditional financial indicators.

Financial indicators used to build an index demonstrate the maximum ability to predict the probability of bank failure.

That is, the Ukrainian banks, in which the values of the indicators were lower, became bankrupt more often than their competitors during the analyzed period of 2014-2017

Bank_FinScore Index Components

Financial indicator
FORMULA
Block 1. NBU regulations
Financial indicator

Н1 - Regulatory capital

FORMULA

RC = Equity + Additional Equity-Corrections

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Capital standard, which indicates the size of the bank regulatory capital, which must exceed the minimum established. Regulatory capital is one of the most important bank indicators, which main purpose is to cover the negative effects of various risks. To determine the real size of regulatory capital with regard to risks bank are obliged to constantly evaluate the quality of active banking operations in their activities.

Financial indicator

Н2 - Regulatory capital adequacy standard

FORMULA

«the ratio of regulatory capital to total book value of assets and off-balance sheet liabilities, weighted by the degree of credit risk»

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Capital standard, which is the ratio of regulatory capital to the total book value of assets and off-balance sheet liabilities, weighted by the degree of credit risk. The regulatory capital adequacy standard reflects the bank’s ability to pay for its obligations arising from trade, credit or other monetary transactions in a timely manner and in full. The higher the value of the indicator of adequacy of regulatory capital, the greater the proportion of risk that bank owners assume. The value of the N2 standard of operating banks must be at least 10%.

Financial indicator

H3 - Сapital adequacy ratio

FORMULA

«regulatory capital-to-risk weighted assets ratio»

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Capital standard, which is the ratio of fixed capital to the amount of assets and off-balance sheet items of the bank, multiplied by the corresponding credit risk ratios. The Сapital adequacy ratio reflects the level of protection of the bank’s assets in terms of the adequacy of the 1st level capital - the main part of regulatory capital, which includes the bank’s shareholders funds in the authorized capital, reinvested profits, equity differences, reserve funds, general reserves, and reserve funds. The higher the value of the Сapital adequacy ratio (H3), the greater the risk the bank owners carry. The normative value of the H3 of existing banks has to be at least 7%.

Financial indicator

LCR - Liquidity Coverage Ratio

FORMULA

«ratio of bank high-quality liquid assets to the amount necessary to cover increased outflow of funds from the bank within 30 days»

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Liquidity standard that sets the minimum required liquidity level to cover the net expected cash outflow over 30 calendar days, taking into account the stress scenario. Due to the transition of banks to the liquidity ratio (LCR) calculation, the National Bank has canceled the less stringent economic standards of instant liquidity (H4) and current liquidity (H5) starting from September 2, 2019. The LCR regulatory value of existing banks has to be at least 90% percent - starting from June 1, 2019; 100% - starting from December 1, 2019.

Financial indicator

Н6 - Short-term liquidity standard

FORMULA

«the ratio of assets to liabilities with a deadline of up to 1 year»

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Liquidity standard, defined as the ratio of assets to liabilities with a deadline of up to one year. This standard establishes the minimum required amount of assets to ensure the fulfillment of its obligations for one year. The value of the H6 standard must be at least 60%.

Financial indicator

Н7 - Maximum credit risk standard per contractor

FORMULA

«the ratio of the total amount of all claims of the bank to persons connected with the bank and the amount of all financial liabilities provided by the bank about persons connected with the bank to the regulatory capital of the bank»

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Credit risk standard, established to limit credit risk arising from the failure of individual contractors to meet their obligations. The standard of the maximum amount of credit risk per contractor is defined as the ratio of the sum of all bank claims to a contractor or a group of related contractors and all financial obligations provided by the bank for the contractor or a group of related contractors to the bank regulatory capital. The value of the H7 standard should not exceed 25%.

Financial indicator

Н8 - Large credit risks standard

FORMULA

«the ratio of the sum of all major credit risks for contractors, groups of related contractors, all persons related to the bank to the regulatory capital of the bank»

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Credit risk standard, established to limit the concentration of credit risk for an individual contractor or a group of related contractors. The credit risk that a bank has assumed for a contractor or a group of related contractors, all persons associated with the bank is considered large if the sum of all the bank’s claims on the contractor or group of related contractors, all persons associated with the bank and all financial obligations provided by the bank to that contractor or a group of related contractors, all persons associated with the bank, is 10% or more of the regulatory capital of the bank. The standard of large credit risks is defined as the ratio of the sum of all large credit risks by contractors, groups of related contractor, all persons related to the bank to the bank regulatory capital. The value of the H8 standard should not exceed 8 times the size of the regulatory capital of the bank.

Financial indicator

Н9 - Standard of maximum amount of credit risk on transactions with related parties

FORMULA

«the ratio of the total amount of all bank claims to persons related to the bank and the amount of all financial obligations provided by the bank on persons related to the bank to the regulatory capital of the bank»

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Credit risk standardestablished to limit the risk of operations with persons associated with the bank, reduce the negative impact of operations with persons associated with the bank on the bank’s operations. The H9 standard is defined as the ratio of the cumulative sum of all bank claims to persons related to the bank and the amount of all financial obligations provided by the bank on persons related to the bank to the bank regulatory capital. The value of the H9 standard should not exceed 25%.

Financial indicator

Н11 - Standard of investment in securities for each institution

FORMULA

«the ratio of the amount of funds that are invested to purchase shares and investment certificates for each institution in the authorized capital of the bank»

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Investment risk standardestablished to limit the risk associated with investing in stocks, shares, and investment certificates of an individual. The ratio of investing in securities for each institution is defined as the ratio of the amount of funds that are invested to purchase stocks, shares, and investment certificates for each institution in the authorized capital of the bank. The value of the H11 standard should not exceed 15%.

Financial indicator

Н12 - Total investment standard

FORMULA

«the ratio of the amount of funds invested in the purchase of shares and investment certificates of any legal entity in the authorized capital of the bank»

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Investment risk standard established to limit the risk associated with the implementation of bank investment activities. The ratio of the total amount of investment is defined as the ratio of the amount of funds invested in the purchase of stocks, shares, and investment certificates of any legal entity in the authorized capital of the bank. The value of the H12 standard should not exceed 60%.

Financial indicator

Н13-1 - Risk standard of total long open currency position

FORMULA

«the ratio of the total long open currency position of the bank for all foreign currencies in hryvnia equivalent to the regulatory capital of the bank»

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Currency risk standarddefined as the ratio of the total value of the bank long open currency position for all foreign currencies in hryvnia equivalent to the regulatory capital of the bank. Critical standard value is up to 10%.

Financial indicator

Н13-2 - Risk standard of the total short open currency position

FORMULA

«the ratio of the total short open currency position of the bank for all foreign currencies in hryvnia equivalent to the regulatory capital of the bank»

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Currency risk standarddefined as the ratio of the total amount of the short open currency position of the bank for all foreign currencies in hryvnia equivalent to the regulatory capital of the bank. Critical standard value is up to 5%.

Block 2. Financial ratios
Financial indicator

Equity-to-Assets

FORMULA

Equity-to-Assets = Equity / Net Assets x 100%

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Capital adequacy indicator, characterizing the share of equity of the bank in the total assets. The higher the ratio, the more financially independent the bank is from its creditors and the risks of panic among depositors.

Financial indicator

Capital adequacy

FORMULA

Capital Adequacy = (Share capital + Unregistered share capital + Subordinated debt) / Net Assets x 100%

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Capital adequacy indicator characterizing the share of the authorized and subordinated capital of the bank in the total amount of assets. The higher the ratio, the more financially independent the bank is from its creditors and the risks of panic among depositors.

Financial indicator

LLR-to-Gross Loans

FORMULA

LLR-to-Gross Loans = Provisions for impairment of customer loans / Total Assets x 100%

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Credit risk indicatorindirectly indicating the share of toxic loans in the portfolio of the bank’s assets, since the amounts of required reserves for credit risks are inversely dependent on asset quality.

Financial indicator

NIM - Net interest margin

FORMULA

NIM = Net Interest Income / Working Assets x 100%

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Performance indicatordemonstrating the ability of the working assets of the bank to generate net interest margin. The larger the indicator, the greater the basis for the formation of bank profits.

Financial indicator

CIR - Cost income ratio

FORMULA

CIR = General operating expenses / Total income x 100%

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Performance indicatorreflecting the level of bank operating expenses compared to the income received. High level indicates a weaker financial condition of the bank and problems with cost management.

Financial indicator

Operating ROA

FORMULA

Operating ROA = (Profit before tax + Deductions to provisions for loan impairment) / Assets x 100%

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Performance indicator, what is the basis for assessing the bank profitability without taking into account the effect of deductions on the formation of reserves, thus more accurately reflecting the operational efficiency due to abstraction from losses associated with the toxicity of bank assets.

Financial indicator

ROA - Return on assets

FORMULA

ROA = Net Profit / Assets x 100%

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Performance indicatordemonstrating what profit each RUB of bank assets brings. The ratio shows how effectively management uses the assets of the bank to generate profits. Negative values indicate loss.

Financial indicator

ROE - Return on equity

FORMULA

ROE = Net Profit / Equity x 100%

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Performance indicatordemonstrating what profit each UAH of bank equity generates. The higher the ratio, the better the bank uses its own capital to generate profits. Negative values indicate loss.

Financial indicator

Cash-to-Liabilities

FORMULA

Cash-to-Liabilities = Cash and cash equivalents / Liabilities x 100%

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Liquidity indicatorcharacterizing the ability of the bank to repay its obligations for cash. The indicator gives an understanding whether the bank has the resources to pay off the claims of creditors and depositors.

Financial indicator

Cash-to-Assets

FORMULA

Cash-to-Assets = Cash and cash equivalents / Assets x 100%

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Liquidity indicator, characterizing the structure of liquidity of the bank's assets, and therefore the sufficiency of the volume of highly liquid assets. The indicator allows to understand what proportion of assets the bank holds in liquid form (not only cash, but also trading securities and accounts in other banks) to quickly repay the claims of creditors and depositors.

Financial indicator

LIQ - Share of liquid assets in total assets

FORMULA

LIQ = (Cash and cash equivalents + Securities in the trading portfolio + Funds in other banks) / Assets x 100%

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Liquidity indicator, що характеризує структуру ліквідності активів банку, а отже достатність грошових коштів. Індикатор дозволяє зрозуміти, яку частку активів банк тримає у найбільш ліквідній формі, що дозволяє швидко погашати вимоги кредиторів і вкладників.

Financial indicator

Nonprofile Assets Share

FORMULA

Nonprofile Assets Share = (Investments in associates and subsidiaries + Investment property + Fixed assets and intangible assets) / Assets x 100%

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Investment risk indicatordemonstrating the share of non-core assets of the bank, such as investments in associates and subsidiaries, investment real estate, fixed assets and intangible assets. High indicators may reflect an underperforming business model of the bank and high sensitivity to market risks of asset impairment.

Block 3. Qualitative reliability factors
Financial indicator

Access to resources and reliability of the beneficiary

FORMULA
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Qualitative indicator, which depends on the level of reliability of the bank’s access to financial support from shareholders, is determined by the sovereign credit rating of the country of origin and geopolitical risks for foreign banks, as well as the ability to access state budget resources for domestic banks.

Розрахунок індексу Bank_FinScore

The value of each indicator included in the Bank_FinScore index is automatically converted to points from 1 to 4 depending on the location relative to the empirical quartiles of the distribution of the corresponding indicator values for the remaining TOP-40 banks in the market in terms of net assets. If the bank indicator value tends to the maximum positive value in terms of financial stability, the bank receives 4 points for this indicator. Banks with the worst scores get lower scores.

Example:

The empirical quartiles of the distribution of the net interest margin (NIM) for the year under study in the banking sector were [0%, 1%, 5%]. Therefore, the score for this indicator for banks is calculated as:

If NIM > 5%, the bank gets 4 points.

Якщо 1 < NIM < 5%, банк отримає 3 бали.

Якщо 0% < NIM < 1%, банк отримає 2 бали.

Якщо NIM < 0%, банк отримає лише 1 бал.

Points of the other indicators-components of the Bank_FinScore index are calculated similarly.

The Bank_FinScore overall index is calculated by the formula:

youcontrol

Fi – discrete point received by the bank on a factor expressed by indicator i. Restrictions: youcontrol

Wi – weight of factor Fi — Constraint: youcontrol

n – number of index indicators. n= 25.

For banks with no possibility to calculate the full list of indicator components, as well as small banks below No. 40 in terms of assets, the Bank_FinScore index is not calculated. However, the values of the existing components of the index can always be found on the YouControl website.

Letter value calculation of Bank_FinScore

Letter value calculation of Bank_FinScore Based on the numerical value of the Bank_FinScore score (from 4 to 1), each studied bank is assigned the Bank_FinScore letter value, which reflects the relative level of financial reliability within the market.

A

High level of financial sustainability
Above Bank_Finscore upper distribution quartile

B

Good level of financial sustainability
Above Bank_Finscore distribution median

C

Satisfactory level of financial sustainability
Above Bank_Finscore bottom distribution quartile

D

Unsatisfactory level of financial sustainability
Below Bank_Finscore lower distribution quartile

Letter value calculation of Bank_FinScore

Letter value calculation of Bank_FinScore Based on the numerical value of the Bank_FinScore score (from 4 to 1), each studied bank is assigned the Bank_FinScore letter value, which reflects the relative level of financial reliability within the market.

Bank_FinScore historical predictive ability

The effectiveness of the financial scoring model offered by the YouControl analytical department is confirmed by the history of bankruptcies of Ukrainian banks, most of which showed negative values of NBU standards and calculated financial ratios.

Keep in mind

The purpose of the Bank_FinScore calculation is an express analysis of the level of financial sustainability of the bank, on the results of which you can quickly decide for further in-depth research. Please note that the index is not a credit rating, since the latter requires more detailed expert analysis and additional consideration of a number of qualitative factors, in particular, the level of external support, shareholders' reputation and other operational and legal risks.

The Bank_FinScore index is probabilistic, therefore, even the maximum index values do not provide a 100% guarantee of financial stability, but only indicate a relatively low probability of such a bank failing. This is an information product that reflects YouControl opinion on the overall level of financial sustainability. The final decision on the financial reliability of the bank should be made by users taking into account other, including qualitative, factors and additional sources of information.

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