Thursday, June 3, 2010

Basic criteria for valuing a financial institution

Financial Institution main business raise money from the public and lend this in the market ,Interest on the lending is the prime source of earning and the interest on deposited is the main expenditure .Now the whole ability of the management governed how the institute collect money from general public at low rate .
Basic criteria a financial analyst follow for valuing a financial institution as summed up by the CRAMEL model. In this model factors like Capital Adequacy Ratio, Resource raising ability, the quality of assets, the quality of the management, earning quality and leverage are analyzed and conclusion reached.
1.Capital Adequacy ratio: capital consist of assets, again assets divided in high risky and low risky. Risk of the assets increases with the risk of the assets.The ratio of the risk weighted assets of an Financial Institution referred to as Capital Assets Ratio.
2.Resource Raising Ability: Ability of the financial institution measures by their ability of raising fund from market at economic rate, and the fund raiser at short span of time.
3.Assets quality : when the financial institution lend their fund on that time they need to measure the riskiness of the assets .They need to check the credit worthiness of the institution where the fund invested also need to check how the fund used by the lending company and where the investment made by the lending institution.
4.Management Quality: Constitution of the Board of Director. Further the competence, technical expertise and objective of the senior management team, the management system like ALM management, portfolio and risk management and mechanism of the internal audit are also consider.
5.Earning Quality: Financial institution main source of income is the interest on the lending amount. Financial institution need to check that change in the interest rate has any affect on the income of the institution.
6.Liquidity : Liquidity of the Financial Institution effect on the business of the financial institution, keeping this in view its average borrowing tenure is always exceed the average tenure of the investment.
Under this category one may look at debt equity ratio, the interest coverage ratio, the borrowing profile and tenure of the investment.

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