Linking profits to asset-liability management of domestic and foreign banks in the UK

Abstract

This paper employs the statistical cost accounting method on a sample of 36 domestic and 44 foreign banks operating in the UK over the period 1996–2002 to examine the relationship between profits and asset-liability composition. The sample was initially split into high and low profit banks by comparing their operating profit with the industry average. The results show that high profit banks experience considerably lower cost of liabilities for most sources of funding, which can cover any losses from the lower rate of return on assets that they experience compared to their lower profit competitors. The sample was then split into domestic and foreign banks. The operating profit that domestic banks experience appeared to be generated by the loans that they hold on their earning assets portfolio and their fixed assets while the operating profit of foreign banks was generated by all the assets that comprise their portfolios. Turning to liabilities, in both cases customer and short-term funding was found to be more costly than other sources of funding.

Notes

 Operating profit is calculated as interest received minus interest paid plus net fee and commission income plus net dealing income plus other operating income. The last item in the equation (i.e. other operating income) includes various items such as sundry operating income, increase in value of long-term assurance policies, investment securities gains, other operating income, other non-banking income. As Hester and Zoellner (1966) mention, among profit before taxes, profit after taxes and operating profit, the latter is expected to have the most stable relationship to portfolio variables.

 Minh To and Tripe (2002) use the same transformation in their variables in order to examine the performance of foreign-owned banks in New Zealand.