Lesson 1 of 7
Reading a bank
A bank is read on net interest margin, credit costs and the efficiency ratio, because debt-to-equity and EV/EBITDA describe its raw material, not its risk.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
Who writes thisEditorial processLinkedIn (opens in a new tab)X (opens in a new tab)
In one minute
- A bank earns a spread between what it pays for deposits and what it charges to lend, not a margin on a product it makes.
- Debt is a bank's raw material, not a warning sign, so debt-to-equity and EV/EBITDA, built for companies that sell a product, say little about a bank.
- Its own three numbers are the net interest margin, the cost of credit and the efficiency ratio, plus regulatory capital measured by regulators' own ratios, not debt-to-equity.
A bank is read through what it earns on the gap between what it pays for money and what it charges to lend it, what it loses when borrowers do not repay, and how cheaply it runs its branches and staff. None of that shows up in the ratios built for a company that sells a product.
From interest income to pre-tax profit
- Interest income$500
- Interest expense−$200
- Net interest income= $300
- Provisions for credit losses−$40
- Operating costs−$160
- Pre-tax profit= $100
Net interest income is the product
Net interest margin equals Net interest income divided by Average earning assets.
Example$300 ÷ $6,000 = 5.0%
A bank takes in deposits and other funding, pays interest on them, and lends the money out at a higher rate. The gap, scaled against the loans and securities that earn it, is the net interest margin. It moves with the level of interest rates and with how much of the bank's funding is free (non-interest checking deposits) against how much is paid for (time deposits, wholesale borrowing). Regulation S-K Subpart 1400 requires the statistical tables behind this figure: average balances, the rate earned or paid on each, and a volume-and-rate analysis. That analysis splits a change in net interest income into how much came from size and how much from price.
Credit costs, the second line
A loan book is a promise to be repaid, and some promises break. Provisions for credit losses are the current year's charge against profit for loans expected to go bad, built up in an allowance on the balance sheet and drawn down when a loan is actually written off. Under current US rules the allowance covers losses expected over a loan's whole life, so a darker economic forecast raises it too, not only a loan actually going bad. A rising provision against a flat or falling loan book is the earliest signal that the quality of what was lent is changing, well before a loan is written off.
The efficiency ratio
Regulatory capital, not debt ratios
Bank regulators set a capital requirement instead: common equity tier 1 capital, a defined measure of loss-absorbing equity, held against risk-weighted assets, with a separate tier 1 leverage ratio against total assets as a backstop. A mortgage and an unsecured loan of the same dollar size carry different risk weights, so two banks with identical balance-sheet size can hold very different capital. Regulation S-K Subpart 1400, adopted in 2020, also requires the credit ratios: the allowance against total loans, nonaccrual loans against total loans, and net charge-offs against average loans (Item 1405).
Price to book, against return on equity
Justified price to book equals Return on equity − growth divided by Cost of equity − growth.
Example(12% − 4%) ÷ (10% − 4%) = 1.33x
A bank's assets are mostly loans and securities carried near their value, so book value is a meaningful anchor, and a bank earning more than its cost of equity is worth more than book. Among 536 US Financial Services companies with a computed price to book, a group that includes insurers and asset managers as well as banks, the median was 1.35x (built 2026-09-07 from prices last stored 2026-08-26).
Do it on a real 10-K
- Find the average-balance table in the Subpart 1400 disclosure and check what funded the growth in earning assets.
- Read the rate-and-volume table to see how much of the change in net interest income came from rate against size.
- Follow the allowance for credit losses roll-forward: the opening balance, the provision, charge-offs, recoveries and the closing balance.
- Compare the efficiency ratio using the bank's own definition of revenue against the one this lesson uses.
Check yourself
A bank's liabilities rise because deposits grow. What does that say on its own?
- The bank is becoming overleveraged
- Little on its own: deposits are the bank's raw material, not debt taken on to buy an asset
- Its efficiency ratio has worsened
Show the answer
Answer: B.
Deposit growth funds new lending. It is not the same signal as a manufacturer borrowing more against its assets, which is why debt-to-equity is not read on a bank the way it is read elsewhere.Net interest income is $300 and operating costs are $160. What is the efficiency ratio?
- 46.7 percent
- 53.3 percent
- 160 percent
Show the answer
Answer: B.
160 divided by 300 is 53.3 percent. A lower efficiency ratio means less revenue is spent running the bank.A bank's loan book is flat but its provision for credit losses is rising. What does that most likely signal?
- The efficiency ratio is improving
- The bank expects more of the existing book to go bad
- Net interest margin is expanding
Show the answer
Answer: B.
A rising provision against a flat book is a charge for loans the bank now expects to go bad, usually visible well before an actual write-off is recorded.Sources
- Regulation S-K Subpart 1400, statistical disclosures by bank and savings and loan registrants, adopted 2020.
What this leaves out
- A thrift or a bank holding company with a large trust or broker-dealer business can carry figures a pure commercial bank does not, and this lesson does not separate them out.
- Banks adjust the efficiency ratio differently (some exclude amortisation of intangibles or put interest on a tax-equivalent basis), so a comparison across two banks needs the same formula on both.
- The waterfall and the efficiency ratio use round invented numbers so the arithmetic can be checked by hand.
- Nothing here is advice about any security.