Factor definitions (FD)
All factors have specific definitions. Below are detailed explanations for all 14 factors.
Scaling guide (SG)
All factors are scored on a scale of 0 to 10 (where 0 is the lowest and 10 the highest). Below are examples of situations where banks would score 0, 5 and 10.
MANAGEMENT & GOVERNANCE
Management & Governance
Depth & Quality of Management
FD This factor pertains to the quality of the management team of the bank and its fitness for executing the banks stated strategy. Main considerations should be whether the executive management team (CEO, CFO, divisional leaders) has a track record of running a similar-sized bank or, if not, the requisite experience of leading a large organization. Intimate knowledge of the bank is a plus.
SG 0= Deeply inexperienced team that is new to the bank, with skill sets not suited to executing the strategic plan. Management ranks lack depth, with no qualified sub-ordinates readily able to take the place of senior managers.
5= Experienced leadership team, but with limited knowledge of the bank and its main business lines and markets, or inexperienced leadership team with strong knowledge of the bank and its main business lines and markets.
10= Experienced leadership team with deep operational knowledge of the bank backed by experienced senior managers that could easily assume leadership roles to the same high standard.
FD This factor pertains to the stated business strategy of the bank. Analysts should consider how clear the strategy is, its suitability to the near-term economic/financial/industry environment. Particular attention should also be paid to the risk appetite that the strategy demands, whether stated or implied, and if it is appropriate for market conditions. Please also consider the bank's suitability to the strategic path from a cultural, experience, expertise and geographic footprint perspective.
SG 0= Strategy is vague with no vision or with financial outcomes that are an incorrect reading of the economic/financial/industrial environment. Management has not articulated a clear execution plan or milestones. The attributes required to execute are not in common with the bank's strength, experience, geographic footprint or expertise, hence execution is fraught with risk.
5= Strategy, while clear, may lack vision/financial ambition or vice versa and does not necessarily capitalise on economic/financial/industry environment trends. Although there is a stated execution plan, it may lack measurable milestones. Though the strategy capitalises on some of the bank's inherent strengths around experience, geographic footprint and expertise, execution still contains large risks.
10= Strategy is very clear, with stated vision, aims and good financial upside that capitalises on the economic/financial/industry environment. A clear and measurable execution plan has been communicated, including details around resources required and specific milestones to be achieved. The strategy capitalises on the inherent strengths of the bank around experience, geographic footprint and expertise, and thus execution risk is likely minimal.
FD This factor pertains to the progress made in executing the bank's stated strategy and likelihood of management achieving its key stated strategic goals and KPIs, including financial metrics within stated timeframes. Where appropriate, demonstrated ability to refine the bank's strategy based on important changes to external factors.
Progress the executive management team (CEO, CFO, divisional leaders) has made against stated milestones of the strategic plan.
Management track record in resolving key issues and barriers to the bank achieving its stated strategic and financial objectives, either within the bank or from previous executive roles.
SG 0= Progress has been minimal against key milestones, and management will not achieve the bank's stated goals and KPIs within the stated timeframe. Targets have been revised repeatedly due to poor execution and still not achieved. Management lacks credibility and lacks a track record of resolving the key issues facing the bank.
5= Progress has been made against key milestones but management may not achieve all the bank's stated goals and KPIs within the stated timeframe. Targets have been revised due to external factors but achieving them is uncertain. Management is still credible but only has a patchy track record of resolving the key issues facing the bank.
10= Good progress has been made against key milestones and management will achieve all the bank's stated goals and KPIs ahead of the stated timeframe. Targets have been revised upwards due to strong execution, and achieving them is very likely to result in financial performance that is ahead of original expectations. Management is very credible, having resolved the key issue facing the bank and is likely to be able to build important competitive advantage for the bank in the near term.
Quality & Strength of Board Oversight
FD This factor pertains to the strength of oversight exerted by the board on executive management and the rigour of its scrutiny of management's strategy and execution. Analysts should consider the following when assessing this factor:
- Composition – Boards should be comprised of individuals with: relevant experience (especially of banking and the geographic markets the bank operates in. Where the board lacks banking experience a bank should score no more than a 7 in this factor); independence from executive management; and track record as a non-executive director of large enterprises.
- Structure – Boards should be structured so that it is efficient in discharging its duties with relevant committees, particularly shareholder disbursements and management compensation. The board should also have in place policies that minimise potential conflicts of interest.
- Track record – Boards (or its members as non execs from another large enterprise) should have a track record of holding management to account and communication to shareholders on corporate actions.
SG 0= The Board is comprised of individuals with no relevant experience of banking, the key jurisdictions in which the bank operates or large enterprises. Its structure is either unwieldy or has too few members to be effective and is not fit for the purpose as a board of a big enterprise, without audit, remuneration, risk and regulatory committees. The board has a very poor track record in holding management to account, and its communication to shareholders has been poor, leading to miscommunication and confusion around important corporate actions.
5= The Board meets some of the above criteria but does not do so convincingly, paying lip service to the accepted standards of a board of a large enterprise, and it lacks the necessary independence or structures to successfully hold management to account.
10= The board fulfils all the above criteria in an exemplary fashion and has demonstrated it has the structures, experience and track record of scrutinising management strategy and performance.
Transparency & Quality of Reporting
FD This factor rates the clarity and timeliness with which the bank reports its financial performance and status of its balance sheet, the guidance it gives the market on salient issues such as: market conditions, credit and risk exposures to sectors, geographies, asset classes and the likely impact these are going to have on returns and capital position. This factor should also include the manner in which a bank gives guidance on its provisioning in terms of contingent liabilities, including regulatory/legal liabilities and the track record the bank has in this area.
For reporting of asset quality banks should be judged on FASB 157 criteria and the score should take into account the level of clarity around all asset levels. In particular, banks should be judged on the credibility of observable inputs utilised in providing level-2 asset valuations and the models that underpin the valuation of level-3 'hard to value' assets.
SG 0= Reporting is poor both in terms of transparency and timeliness, with no granularity to exposures required for analysing the bank's performance. Historic reporting is constantly revised and future guidance is non-existent. There are constant surprises in terms of regulatory/legal liabilities and revenues/costs that impact reported income and for which there was no guidance. There is no guidance given to concentration of assets and exposure and the granularity of reporting on assets is very poor, with no granularity. The observable inputs and models that underpin level-2 and level-3 assets are not robust and lack rigour (FASB 157).
5= Reporting is adequate in terms of transparency and timeliness, with sufficient granularity to analyse the bank's performance, but is often presented in a manner that is hard to use: lengthy reports with many footnotes and appendices spread throughout the document. Historic reporting may be revised periodically, but this is not a constant behaviour for this bank. Although future guidance is given, it often lacks granularity in terms of sector/geographic and concentration exposure, making it difficult to assess the likely impact to the bank's financial performance and does not make it a very reliable guide to crystallised losses. Guidance around legal/regulatory issues is often vague, and even where provisions are made they are often wide of the mark versus the crystallised costs. Level-2 or level-3 asset reporting often lacks detail, while the observable inputs and valuation methods, though adequate, are not the most rigorous.
10= Reporting is exemplary in terms of transparency and timeliness with almost no revisions. All data and commentary is presented in an easy-to-use manner that focuses on relevant information that is easy to navigate. Granularity of reporting is excellent, giving investors all required information to analyse the bank's performance in a timely manner. All potential regulatory/legal liabilities are disclosed well in advance, with crystallised liabilities coming in very closely to the guidance given. Future guidance is strong and is given to levels of granularity in keeping with reporting of actuals, giving investors a consistent picture of the bank's performance. Particular care is take to disclose concentrations in the asset book. The reporting of different levels of assets is very clear, with detailed disclosure of level-3 asset types; valuation models used are appropriate with detailed explanations.
Operational Risk Control
FD Risks are defined as operational risks that can have regulatory/legal implications and penalties. This factor covers the senior management’s:
Awareness and understanding of the risks that affect the business lines of the bank. The framework senior management should demonstrate experience and knowledge of the different business lines of the bank and, where the activities are more esoteric in nature, then that experience becomes more of a pre-requisite;
Risk-control framework and processes to assess, monitor, manage and adjust the bank's operational risk exposure, including through its compensation structures to manage any conflicts of interest. If a bank operates in a large number of jurisdictions where legal compliance can be challenging, such as emerging and frontier markets, then the operational risk framework it has in place should reflect this through increased rigour;
Commitment to managing and controlling risks to the levels and standards stated or implied by the bank's corporate strategy.
SG 0= The senior management’s understanding of the risks that the bank is exposed to from operational sources is negligible and their experience is entirely deficient for the risk profile that the bank exhibits. Operational risks are not managed to the appropriate degree and the bank exhibits a consistent track record of regulatory enforcement actions and legal liabilities that result in large fines/financial settlements.
5= Senior management demonstrates adequate understanding of the operational risks that the bank is exposed to, matching the bank's risk profile. Operational risk-control frameworks are in place but not enforced rigorously and consistently, resulting in some regulatory/legal liabilities that act as a periodic drag on financial performance.
10= Senior management demonstrates complete understanding of the operational risks that match the bank's risk profile. Operational risk-control frameworks are well codified and enforced rigorously and consistently, resulting in almost no regulatory/legal liabilities. Furthermore, the cumulative effect of this risk-focused approach means a culture of risk awareness has been created that permeates to all levels of the bank and conduct is completely in-line with stated policy and prevailing regulations.
Quality of Earnings
FD Earnings quality is a measure of the sustainability and predictability of a banks earnings. The more the bank's earnings are exposed to risks of them turning to losses then the lower the quality of those earnings. Euromoney does not deem any particular line of business – investment banking, retail banking, transaction banking, etc. – to be more or less sustainable and believes individual analyst opinion is the most important factor in deciding this. Aspects of a banks earnings to take into account are:
Concentration. Earnings are deemed to be of higher quality if they are generated from a larger range of activities that serve a larger base of clients from a wide range of sectors and geographies; and
Market position. Earnings are deemed to be of higher quality the greater the competitive advantage that a bank has in the activities that generate those earnings.
SG 0= The banks’ earnings are completely generated from one-off activities with no reasonable likelihood of recurring. Net interest income is almost non-existent and is generated from a net interest margin (NIM) that is very small; this NIM would become negative should funding costs rise just slightly. All earnings activity is generated from a very small group of clients from a specific sector and geography, hence earnings are highly concentrated.
5= The majority of the bank’s earnings are generated from activities with a reasonable likelihood of recurring and hence are predictable, although some is of a one-off nature. Interest income is generated from a net interest margin (NIM) that is reasonable, the bank’s earnings have a strong sensitivity to the NIM but would only become negative should funding costs rise a lot. Earnings activity is generated from a large group of clients but lacks diversity, with a skew towards particular sectors and geographies that makes earnings sensitive to the business climate in these markets. The bank has no competitive advantage in any of its main activities, usually operating in crowded segments of the banking industry.
10= All of the bank’s earnings are generated from activities of a highly predictable and recurring nature, this has been proven over a long period of time. Interest income is generated from a net interest margin that is much higher than peers, due to a combination of balance-sheet strength that allows for lower funding costs and higher interest charges due to the strength of the bank's franchise. Earnings activity is generated from a very large and diverse group of clients, without any skews towards particular geographies or sectors; that means the bank’s earnings are not significantly impacted by the climate in a few specific economic sectors or geographic markets. The bank has large competitive advantages in all of its main activities, sometimes enjoying an oligopolistic position. Even when it operates in crowded segments of the financial services industry, it has a leadership position that translates into strong earnings recurrence.
Quality of Assets
FD Asset quality is a measure of the quality of the overall asset base of the bank. These factors should be taken into account when considering a bank's score:
Concentration. An asset base is of high quality if it is comprised of exposures to a highly diversified group of credits and counterparts. In corporate/commercial banking this is measured by industry sector and geography diversity; in retail banking this is measured by product and 'vintage' diversity (such as mortgages to buy-to-let investors or asset finance for consumer durables in specific regions);
Credit quality. An asset base is of higher quality if it is comprised of exposures to borrowers higher up the credit spectrum, such as investment-grade credits in wholesale banking and prime borrowers in retail baking; and
Liquidity. An asset base is of higher quality if it is comprised of assets that are highly liquid in nature and can be liquidated at short notice, causing minimal market impact. FASB 157 rules for level-1, 2 and 3 assets can be taken as a good proxy for liquidity levels of assets.
SG 0= The bank’s asset base is extremely concentrated in terms of counterparty and credit in commercial banking and/or specific products and borrower types in retail banking. Credit quality is poor as all credits are towards the bottom of the credit spectrum. The asset base is highly illiquid with a large proportion in FASB 157 level-2 and level-3 assets. Therefore the bank's sensitivity to underlying markets is very high and should they deteriorate this would erode the balance sheet badly and impact the bank’s capital levels; liquidating assets to compensate would not be possible.
5= The bank’s asset base shows some skews in concentration towards sectors and geographies in commercial banking and/or specific products and borrower types in retail banking. Credit quality is average, with a spread of assets throughout the credit spectrum. The asset base has a fair proportion of FASB 157 level-2 and level-3 assets, but the degree of level-1 assets is large enough to cover minor deterioration in market liquidity.
10= The bank's asset base is highly diversified, showing no concentrations. Credit quality is extremely high, with nearly all assets being generated from investment-grade and prime borrowers. The asset base has a very high degree of liquid assets whose value would cover any likely impairments from less liquid assets.
Financial Risk Control
FD Risks are defined as financial risks arising from exposures that the bank has. This factor covers the senior management’s:
Awareness and understanding of the financial risks that affect the business lines of the bank. Senior management should demonstrate experience and knowledge of the different business lines of the bank. Where the activities are more esoteric in nature – such as those that generate a high degree of level-3 assets – then that experience becomes more of a pre-requisite;
Risk-control framework and processes to assesses, monitor, manage and adjust the bank's credit and market risk exposure. If a bank operates in a large number of different but correlated markets, then the framework should take this into account. The valuation methods for level-2 and level-3 assets should be taken into account as it is a key component of the financial risk control framework; and
Commitment to managing and controlling risks to the levels and standards stated or implied by the bank's corporate strategy.
SG 0= Senior management’s understanding of the credit and market risks that the bank is exposed to is negligible and their experience is entirely deficient for the risk profile that the bank exhibits. Credit-risk control frameworks are completely inadequate, with no systematic and consistent risk assessment processes and controls for existing and new credit/counterparty exposures. Level-2 and level-3 asset valuation methods are highly questionable, leading management to misunderstand their risk drivers. There is no systematic process for the management of risk exposures, often leading to high concentrations of risk to individual counterparties, sectors and highly correlated markets that consistently results in large impairments and losses in times of market stress.
5= Senior management demonstrates adequate understanding of the credit and market risks that the bank is exposed to, and their experience matches aspects of the bank's risk profile. Credit-risk control frameworks are adequate, while consistent risk-assessment processes and controls for existing and new credit/counterparty exposures are in place but lack sophistication or are not implemented and followed rigorously. Level-2 and level-3 asset valuation methods are questionable, leading management to misunderstand their sensitivities and correlations. This results in some exposure concentration to individual counterparties, sectors and highly correlated markets, meaning losses can be high in times of market stress.
10= Senior management demonstrates complete understanding of the credit and market risks that the bank is exposed to, and their experience matches the bank's risk profile perfectly. Credit-risk control frameworks are very robust and controls for existing and new credit/counterparty exposures are implemented and followed rigorously. This results in exposures entirely in keeping with the bank's stated strategy. Furthermore the cumulative effect of this risk-focused approach means a culture of risk awareness that permeates to all levels of the bank so that losses during times of market stress are kept to a minimum.
FD Contingent liabilities are defined as liabilities that the bank is exposed to and are declared on its balance sheet. This factor seeks to measure the impact that contingent liabilities are likely to have on a bank’s financial position in the event that the liabilities crystallise. Therefore characteristics to take into account would be:
The total quantum of contingent liabilities;
The likelihood of their crystallising;
The impact to the bank's risk profile in terms of exposure concentration to sectors and geographies for undrawn credit commitments; and
The impact to the bank's earnings from legal/regulatory liabilities.
Examples of contingent liabilities include:
- All undrawn credit commitments and unused loan commitments the bank has made to borrowers such as revolving facilities;
- All off balance-sheet derivative transactions the bank has entered into.
Please note this factor deals solely with the quantum and nature of a bank's contingent liabilities, not the manner and transparency with which they are reported. This is covered in the 'Transparency and reporting' factor.
SG 0= The bank has significant contingent liabilities in the form of both undrawn commitments as well as regulatory/legal liabilities. Both types of contingent liabilities are very likely to crystallise. Undrawn commitments are heavily concentrated in specific sectors and geographies with a handful of counterparts. Regulatory/legal liabilities are of the magnitude that would dwarf any likely earnings for the medium-term future. Without injections of large amounts of loss-absorbing capital, the scale of contingent liabilities would likely call into question the banks viability.
5= The bank has contingent liabilities in the form of both undrawn commitments as well as regulatory/legal liabilities. Both types of contingent liabilities are likely to crystallise, although probably not in full. Undrawn commitments show some concentration towards specific sectors and geographies, and when drawn down will skew the bank's balance sheet towards those sectors/geographies. Regulatory/legal liabilities are of the magnitude that would have an impact on earnings in the current financial year only. In the event that all contingent liabilities crystallise, the bank may require further capital to be injected and would see a deterioration of key capital ratios and leverage levels.
10= The bank has very few contingent liabilities in the form of either undrawn commitments or regulatory/legal liabilities. Undrawn commitments show no concentrations towards specific sectors and geographies, and when drawn down will not skew the bank's balance sheet towards those sectors/geographies. Regulatory/legal liabilities are small and would not have a material impact on earnings in the current financial year and no impact at all on subsequent years. In the event that all contingent liabilities crystallise, they would not impact earnings for the year or capital ratios.
Deposit Gathering Capability
FD A banks deposit gathering capability is a measure of the infrastructure, brand and client penetration that a bank can utilise to generate deposits from corporate, institutional and retail investors.
SG 0= The bank operates predominantly on the asset side of the business with a very limited client base funded by capital raised in the wholesale markets, the majority being short-term funding. The bank operates in countries with a limited market of deposits and the brand is not widely known outside its client base. The bank has very few or no physical branches and offers few or no services associated with retail deposit-taking, such as interest-bearing savings accounts, current accounts, bank cards, an ATM network, etc. The bank also offers very limited services for corporates and institutions, lacking the types of services – cash/liquidity management, supply-chain financing, etc – that would likely attract deposits.
5= The bank operates in a number of areas on both the asset and liability side of the business funded by a mixture of deposits, short-term funding and wholesale capital markets issuance. The bank operates in countries with good-sized markets for deposits and a well-established financial services brand. The bank has a limited number of physical branches, often geographically concentrated; deposit-taking services are not marketed as a key service. The bank's share of the deposit market is small and it offers a limited range of retail deposit-taking products such as interest-bearing savings accounts, current accounts, bank cards, an ATM network, etc. The bank offers limited services for corporates and institutions, lacking the types of services – cash/liquidity management, supply-chain financing, etc – that would likely attract large deposits.
10= The bank is a very large player on both the asset and liability side of the business, funded by a very substantial deposit base supported by short-term funding and wholesale capital-markets issuance. The bank operates in countries with a very large market for deposits and is a very well-established and respected financial services brand. The bank has a very large number of physical branches, a strong web/telephone presence and deposit-taking services are marketed aggressively as a key service. The bank's share of the deposit market is very large and if offers a full range of retail deposit-taking products, such as interest-bearing savings accounts, current accounts, bank cards, an ATM network, etc. The bank also offers a full range of services for corporates and institutions with strong market share in cash/liquidity management, supply chain financing, etc that would likely attract many deposits.
Ability to Raise Loss Absorbing Capital
FD This factor is defined as to what degree the bank can access markets to raise loss-absorbing capital in amounts that would boost the bank's capital position. All contributing factors to successful capital raising should be taken into account including:
Likely financial performance trajectory;
Franchise and brand strength;
Management credibility; and
SG 0= The bank is very poorly capitalised. The bank's financial performance is extremely poor and continued losses are very likely in the near future, further eroding the bank's capital. There have been attempts at capital raising in the past that have been unsuccessful. Management lacks credibility with the market, having consistently failed to fulfil strategic and financial objectives. The management has also misled investors as to the bank’s financial position in the past. The bank has no discernible client base.
5= The bank is adequately capitalised. The banks recent financial performance has not generated substantial returns but has keep its capital position stable. There has been successful capital raising in the medium-term past. Although management is credible with the markets, it has not fully achieved previously stated strategic and financial objectives. The bank has a solid client franchise and brand but has a substantial part of its operations in a financial sector where margins are thin.
10= The bank's capital position is extremely solid with a CET1 ratio that is substantially ahead of regulatory requirements. The CET1 ratio is growing as retained earnings will more than cover the growth of risk-weighted assets. Management is very credible to the market and has previously achieved all stated strategic aims and financial objectives. The bank has a very strong franchise and is highly valued by clients.
Strength of Capital Position
FD This factor is defined as the bank's current total capital and its distribution in the capital structure against whether it is appropriate to the business model of the bank and the likely shocks that the nature of its business mix exposes it to. Characteristics that should contribute to the strength of the capital position include:
Absolute amount of capital;
Proportion of capital in the most senior buckets CT1, AT1 and so on;
Likely amount of retained earnings to be generated in medium term; and
The inherent risk profile of the bank's business model from a capital erosion/consumption point of view, for instance in areas where the below often happens:
Downside revenue shocks that erode earnings;
Regulatory/legal charges that erode earnings;
Losses triggered by market volatility that erode earnings; and
Balance sheet is sensitive to small movements in credit ratings, triggering risk-weight changes and higher capital charges.
SG 0= The bank is very poorly capitalised, especially relative to the risk profile of its business lines. The amount of retained earnings the bank is likely to generate will not contribute to the bank's capital levels. Risk-weighted assets have grown and continue to do so, which will further undermine the bank's capital ratios. The nature of the bank's business model exposes it to market, credit and operational risk for which the bank is wholly inappropriately capitalised.
5= The bank is adequately capitalised. The amount of retained earnings the bank is likely to generate will contribute to the bank's capital levels in a small way. Risk-weighted assets have largely stayed constant and only excessive growth will undermine the CT1 ratio. The bank has slight concentration of exposure to a small number of markets whose risk-weight status is very sensitive to small movements in their credit rating. The nature of the bank's business model exposes it to market, credit and operational risks, but the bank is adequately capitalised for them.
10= The bank is very strongly capitalised and especially so relative to the risk profile of its business lines. The amount of retained earnings the bank is likely to generate will contribute to the bank's capital levels substantially. Risk-weighted assets have shrunk substantially and improved the CT1 ratio. The bank has very small exposures to markets whose risk-weight status is very sensitive to small movements in their credit rating. The nature of the bank's business model exposes it to limited amounts of market, credit and operational risk; the bank is very well capitalised for those risks.
Resilience to Liquidity/ Funding Shocks
FD This factor is defined as the bank's ability to withstand a period of shock to financial markets that would cause liquidity to drop and would likely mean that wholesale funding markets would cease to function normally. Resilience to these shocks would break down to a number of considerations:
The bank's level of reliance on the wholesale funding markets, particularly short-term funding for its capital requirements.
A bank's outstanding bond maturity and calendar concentration of refinancing required.
The bank's bond-issuance profile, including existing currencies and markets that the bank issues in and its investor base in terms of geographic spread.
Proportion of level-1 assets to be liquidated/pledged as collateral during a liquidity shock.
SG 0= The bank has a very high dependency on short-term funding from wholesale markets for its capital requirements and has very low deposit levels. The bank's longer-term debt is concentrated at the shorter end of the curve and its investor base is very narrow. Its issuance has high calendar concentration, rendering it particularly vulnerable to market dislocations during those periods. The bank's proportion of level-1 assets is low and would not cover funding requirements for long when liquidated.
5= The bank utilises short-term funding from wholesale markets for a fair proportion of its capital requirements, although the bank has a substantial deposit base. The bank's longer-term debt is well distributed along the curve and it is an established issuer in multiple currencies, although its investor base is relatively narrow in geographic terms. The maturity profile of the bank's debt shows little calendar concentration, which does not leave it overly vulnerable in any periods. The bank's proportion of level-1 assets would be able cover funding requirements for a good period if liquidated.
10= The bank utilises very little short-term funding from wholesale markets for its capital requirements. The bank utilises longer-term debt for its capital requirements, and this is well distributed in terms of maturity dates, meaning that there are no periods when it would be particularly vulnerable to market dislocation. The bank has well established issuance along the curve, in multiple currencies and its investor base is very diverse in geographic terms. The bank's proportion of level-1 assets is very high and would be able cover funding requirements for a substantial period if liquidated.
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