Evaluation of Financial Performance: A Comparative Study of Selected Commercial Banks in Ethiopia

This study is aimed at evaluating the financial performance and ranking the performance of the selected commercial banks in Ethiopia for the period 2011 to 2017. To meet the objective of the study, secondary sources of data, such as annual reports of the banks have been utilized. After collecting the necessary data, appropriate financial ratios, descriptive statistical techniques and average, percentage, and proportion were employed for analyzing, interpreting, ranking, transformation of data and giving a condensed picture of the collected data. Accordingly, the results of the study revealed that the financial performance of the bank in a measure of profitability CBE, DB and WB occupies the first three positions respectively. In a liquidity measure WB ranks first, BOA ranks second and UB ranks the third position. In a risk and solvency measure NIB, BOA and UB covers the first three positions. In an efficiency measurement CBE occupies the first, WB occupies the second and NB occupies the third position. In the overall measure of banks financial performance WB, NIB and UB occupies the first three positions respectively.


I. INTRODUCTION a) Background of the study
Economy of a country whether it is developed or developing highly supported by service giving organization, among them financial market and financial intermediaries account the larger proportion, but due to financial markets are not well developed in a country like Ethiopia, their economic development and prosperity of the country largely relay on financial intermediaries (banks, insurance companies and micro-finance institutions) particularly commercial banks which accounts eight percent of the total and that accept deposits and channels those deposits in to lending activities. So, the performance of banks through financial statements should be monitored closely and frequently to improve the wealth of the bank, to attract interested parties like investors, creditors and managers, and also largely to improve the economic development of the country. Moreover, it is of great importance to keenly observe the performance of the banks and their compliance with the regulatory requirement.
Even if, financial statement represents historical data and did not consider inflation, Banks prepare financial statement, particularly Balance sheet and Income statement for internal use or for management to make decision about the future and also for external users or to attract mostly investors and creditors. Analyst uses financial statements to measure the performance of the banks and also to indicate the attractiveness and weakness of banks.
Financial statement analysis begins with a set of financial ratios designed to reveal the strength and weaknesses of a company as compared with other companies in the same industry, and to show whether its financial position has been improving or deteriorating over time (Brigham and Houston, 1999).
Ratio analysis is a widely used tool of financial analysis. The term ratio is refers to the relationship expressed in mathematical terms between two individual figures or group of figures connected with each other in some logical manner and are selected from financial statements of the concern. It helps to express the relationship between two accounting figures in such a way that users can draw conclusions about the performance, strengths and weakness of a firm.
The history of banking sector in Ethiopia undergone five distinct periods, the first event was establishment in 1906 of the Bank of Abyssinia, marking the advent of banking into the country. The second event was Italian occupation in 1936, when following liquidation of the Bank of Ethiopia, a broad colonial banking network, extended to encompass all Italian possessions in the Horn of Africa and closely linked with the metropolitan higher profitability and hence more risk. LAR is calculated as under: LAR = Loan / Asset c) Credit Risk and Solvency Ratios This is a class of ratios, which measures the risk and solvency of the bank. These ratios are also referred to as gearing, debt, or financial leverage ratios. The extent to which a firm relies on debt financing rather equity is related with financial leverage. These ratios determine the probability that the firm default on its debt contracts. The more the debt a firm has the higher is the chance that firm will become unable to fulfil its contractual obligations. In other words, higher levels of debt can lead to higher probability of bankruptcy and financial distress. Although, debt is an important form of financing that provided significant tax advantage, it may create conflict of interest between the creditors and the shareholders (Ross, Wedsterfield, and Jaffe 2005). If the amount of assets is greater than amount of its all types of liabilities, the bank is considered to be solvent. Deposits constitute major liability for any type of bank whether Islamic or conventional. To gauge risk and solvency of the bank we use: i. Debt Equity Ratio (DER) The extent to which firm uses debt. It measures ability of the bank capital to absorb financial shocks. In case, creditors default in paying back their loans or the asset values decrease bank capital provides shield against those loan losses. A bank with lower DER is considered better as compared to the bank with higher DER. DER is calculated as under: DER = Total Debt / Shareholders' Equity ii. Debt to Total Asset Ratio (DTAR) It measures the amount of total debt firm used to finance its total assets. It is an indicator of financial strength of the bank. It provides information about the solvency and the ability of the firm to obtain additional financing for potentially attractive investment opportunities. Higher DTAR means bank has financed most of its assets through debt as compared to the equity financing & the bank involved in more risky business. DTAR is calculated as under: DTAR = Total Debt / Total Assets iii. Equity Multiplier (EM) How many times the total assets are of the shareholders' equity is measure by equity multiplier. In other words, it indicates the amount of assets per dollar of shareholders' equity. Higher value of EM means that bank has used more debt to convert into assets with share capital. Generally, the higher is the EM the greater is the risk for a bank. EM is calculated as under: EM =Total Asset / Total Shareholders' Equity iv. Non-Performing Loans to Total Loan Ratio (NPLTL) Non-performing loans are loans that are no longer producing income for the bank that owns them. Loans become non-performing when borrowers stop making payments and the loans enter default. The exact classification can vary from institution to institution, but a loan is usually considered to be non-performing after it has been in default for three consecutive months. Banks often report their ratio of non-performing loans to total loans as a measure of the quality of their outstanding loans. A smaller NPLTL ratio indicates smaller losses for the bank, while a larger NPLTL ratio can mean larger losses for the bank as it writes off bad loans. NPLTL is calculated as under: NPTL = Non-performing Loans/Total Loans d) Efficiency ratios The presence of inefficiencies is considered as an inherent feature of banking. According to Turati (2003:2), "banks are regarded as firms that emerge as a result of some sort of market imperfections; hence they bring about a certain degree of inefficiency with respect to perfect competitive outcome". Banking efficiency is important at both macro and micro levels and in order to allocate resources effectively, banks should be sound and efficient Hassen (2005). These ratios measure how effectively and efficiently the firm is managing and controlling its assets. Higher value of these ratios is taken as good indicator, which means firm is doing well. Ratios used to measure are: i. Asset Utilization (AU) How effectively the bank is utilizing all of its assets is measured by assets utilization ratio. The bank is presumably said to using its assets effectively in generating total revenues if the AU ratio is high. If the ratio of AU is low, the bank is not using its assets to their capacity and should either increase total revenues or dispose of some of the assets (Ross, Westerfield, and Jaffe 2005). Total revenue of the bank is defined as net spread before provision plus all other income. AU is calculated as under: AU = Total Revenue/Total Asset ii. Income Expense Ratio (IER) Income to expense is the ratio that measures amount of income earned per dollar of operating expense. This is the most commonly and widely used ratio in the banking sector to assess the managerial efficiency in generating total income vis-à-vis controlling its operating expenses (Samad& Hassan 2000). High IER is preferred over lower one as this indicates the ability and efficiency of the bank in generating more total income in comparison to its total operating expenses. Total income in the study is defined as net spread earned before provisions plus all other income while the Other Expenses in the income statement are treated as total operating expense for the study. IER  Vol.11, No.7, 2019 75 is calculated as under IER = Total income / Total Operating Expenses iii. Operating Efficiency (OE) OE is the ratio that measures the amount of operating expense per dollar of operating revenue. It measures managerial efficiency in generating operating revenues and controlling its operating expenses. In other words, how efficient is the bank in its operations (Ross, Wedsterfield, and Jaffe 2005). Lower OE is preferred over higher OE as lower OE indicates that operating expenses are lower than operating revenues. Operating revenue is defined as net spread earned before provisions plus fee, brokerage, commission, and for ex income. Other expenses is defined same as we defined in the previous ratio. OE is calculated as under: OE=Total Operating Expenses / Total Operating Revenue

III. DATA ANALYSIS AND INTERPRETATION
In this part of the research, the collected financial data have been analyzed, discussed and interpreted accordingly and then different ratio analysis has been undertaken. a) Ratio Analysis As it was already mentioned, a bank's balance sheet and income statement are valuable information sources to evaluate financial strengths and weaknesses of a bank and its business trends. Although the birr amounts found on these statements provide valuable insights into the financial performance and condition of the bank, the researcher typically used data from them to develop financial ratios to evaluate the bank financial performance. In all of the remainder of this chapter, the researcher used key ratios, liquidity, profitability, efficiency, and credit risk & solvency, commonly used by bank analysts to evaluate different dimensions of financial performance of selected commercial Banks to compare with each other and make time series analysis over recent seven years. So the study first calculated ratios of each of the selected commercial banks from their own consolidated financial statements and compare these ratios with each other in each year, and finally identifying the best performing bank in the industry.
i. Profitability ratios Profitability is a management concept with the objective of assessment bank's results from efficiency point of view both for entirely activity and for differently management compounds. From conceptual point of view, profitability represents the modality to achieve the major goal of bank's activity, respectively the maximization of profit in minimization risk conditions. a. Return on Assets (ROA) ROA is defined as the ratio of profit after tax to total asset. It reflects the efficiency with which banks deploy their assets. The higher the ROA, the most profitable is the bank. It is presented above in table 3.1 that the average value of ROA of WB is 3.08% which is the highest amongst its peer group and is thus ranked first followed by DB with an average value of 2.97% and NIB with average value of 2.89%. The average of net income to total asset ratio of BOA is 2.35% which is lowest among the selected banks and is ranked last.
b. Return on Equity (ROE) This ratio indicates how bank can generate profit with the money shareholders have invested. The higher value of this ratio shows higher financial performance. Like ROA, this ratio is also indicator for managerial efficiency. It is a measure of the profitability of a bank. Profit after tax is expressed as a percentage of equity and an average score of 57.85%, 27.22%, and 22.28% were registered for CBE, DB, and AIB and it has given them the chance to hold first to third of the available ranks respectively. On the other hand, NIB is the one who held the seventh rank with an average rate of return of 17.15% to its shareholders for their investment.
c. Profit to Expense Ratio (PER) This ratio indicates profitability of the firm with regard to its total non-interest expenses. A high value of this ratio indicates that bank could make high profit with a given expenses.  3.4, WB is on the top position with highest average of 4.22% followed by NIB and DB with an average of 3.92% and 3.70% respectively. BOA scored the last position with least average of 2.86% due to the managements of the BOA are inefficient in transforming customers deposit in net earning relative to other banks. e. Net Interest Margin (NIM) Net Interest Margin measures the amount of operating income to earning asset. Higher the NIM ratio, higher is the quality of the management decision. Because higher operating income is the result of higher interest income or comparative lower interest expense, which is charged upon the earning assets such as Short-term Investment, loans and investment.  It is presented in the above table 3.5 that the average value of net interest margin to total assets ratios of BOA is 3.84% which is the highest amongst its peer group and is thus ranked first. BOA is followed by WB and UB with an average score of 3.78% and 3.65% respectively. The average of net interest margin to total assets ratios of DB is 2.65% which is lowest among its group and is ranked last.
f. Overall ranking of Profitability measure The Group Ranking of all the selected banks under the profitability parameter was shown in table 3.6 below. The group ranking is based on the average of individual bank's profitability sub-parameter ranks. The contribution of each bank for specific sub-parameter was converted into hundred percent primarily for not affecting the contribution of one specific-parameter by the other (to make each specific-parameter independent of each other), secondly to protect their contribution for the overall profitability performance as well as the overall performance besides calculating the overall profitability result conveniently. The table below shows the profitability ratios by type of banks and the overall rank position of the banks regarding to profitability. On the basis of group averages of five ratios of profitability measure as expressed in table 3.6, CBE was at the top position with group average of 20.08%, followed by DB and WB with an average of 14.18% and 14.14% respectively. BOA scored the lowest position with 12.16% average ranks due to its poor performance in Return on asset, profit to expense and return on deposit relative to the other banks.
ii. Liquidity ratios The liquidity ratios measure the capability of bank to meet its short-term obligations. Generally, the higher value of this ratio indicates that firm has larger margin of safety to cover its short-term obligations. Among the various liquidity measures, the study uses the following three liquidity ratios.
a. Loan to Deposit Ratio (LDR) Loan to deposit ratio indicates the percentage of the total deposit locked into non-liquid asset. A higher loan to deposit ratio indicates that a bank takes more financial stress by making excessive loan. Therefore, lower loan deposit ratio is always preferable to higher loan deposit ratio. This low value of loan deposit ratio also indicates effectiveness of mediation function of bank. From the above table 3.7, DB is on the top position with least average of 55.88% followed by BOA with average of 58.03% and WB with average 58.86%. DB, BOA and WB are more concerned about the protection of depositors and creditors. CBE scored the lowest position. The extent in which CBE relies on debt financing is higher than other banks rely on debt financing and also the loan provision of the industry is highly dominated by CBE due to the policy of National Bank of Ethiopia.
b. Cash to Deposit Ratio (CDR) Another measure of liquidity of the bank is the cash to deposit ratio. The higher the ratio the better is the liquidity position of the bank, therefore, the more is the confidence and trust of the depositors in the bank as compared to the bank with lower CDR. In the above table 3.8, WB is seen to be relatively at the top with highest average of 20.22% followed by CBE with an average score of 11.32% and BOA with an average score of 9.89%. On the other hand, AIB is the least performer in this regard with an average score of 4.53%.
c. Loan to Asset Ratio (LAR) The loans to assets ratio measure the total loans outstanding as a percentage of total assets. The higher this ratio indicates a bank is loaned up and its liquidity is low. The higher the ratio, the more risky a bank may be to higher defaults.

Figure 3.1 Loan to asset ratio
On the bases of financial ratio analysis or on the above figure, WB stood at first position regarding to LAR with an average of 42.95% followed by AIB with 44.74% and DB with 44.87% of average scores, while CBE secured the least position with an average score of 80.14% due to the loan provision of the banking industry highly dominated by commercial bank of Ethiopia because of the policy of National Bank of Ethiopia and also due of the ages of the assets of the CBE decreases its value than the rest of the banks which are in operation for less than three decades. d. Overall ranking of Liquidity measure The group ranking of all the selected banks under the Liquidity parameter was shown in Table 3.8 below. The group ranking is based on the average of individual bank's liquidity sub-parameter ranks, but from the subparameter CDR was transformed into a meaningful form by taking the reciprocal (1/CDR) for the purpose of comparison with LDR and LAR. Moreover, the contribution of each bank for specific sub-parameter was converted into 100% primarily for not affecting the contribution of one specific-parameter by the other (to make each specific-parameter independent of each other), secondly to protect their contribution for the overall liquidity performance as well as the overall performance besides calculating the overall liquidity result conveniently. The table below shows the average of loan to deposit, cash to deposit and loan to assets by type of banks and the overall  Vol.11, No.7, 2019 rank position of the banks regarding to liquidity. On the basis of group averages of three ratios of liquidity as expressed in table 3.9, WB was at the top position with group average of 10.32%, followed by BOA with average of 12.79% and UB with average of 12.89% respectively. CBE scored the last position with average 18.64% due to its poor performance in Loan to Deposit ratio and Loan to assets ratios.
iii. Risk & Solvency ratios The risk and solvency ratios measure the extent to which a firm relies on debt financing rather than equity financing. These ratios are also referred to as gearing, debt, or financial leverage ratios. These ratios determine the probability that the firm default on its debt contracts. The more the debt a firm has the higher is the chance that firm will become unable to fulfil its contractual obligations. The following ratios measure for risk and solvency were used for the study.
a. Debt to Equity Ratio (DER) Debt to Equity ratio represents the degree of leverage of the bank. This ratio indicates us how the bank finance its operation with debt relative to shareholders' equity. A high value of this ratio provides indication that firm involves in more risky business.

Figure 3.2 Debt to Equity ratio
In the above figure 3.2, WB is on the top position with least average of 4.71 times followed by NIB with average of 5 times and UB, and AIB with average of 7.28 times. WB is more concerned about the protection of depositors and creditors. CBE scored the lowest position with an average of 19.75 times. The extent in which CBE relies on debt financing is higher than other banks reliance on debt financing.
b. Debt to Total Asset Ratio (DTAR) DTAR also measures the ability of the bank capital to absorb financial shocks. This ratio indicates the proportion of assets financed with debt or creditors. A high value of this ratio provides indication that firm involves in more risky business.

Figure 3.3 Debt to Total Asset ratio
As it is evident from the above figure, WB has the least debt to total assets ratio and ranked first. WB is followed by NIB and BOA occupying the second and third position respectively. The last position regarding to DTAR is occupied by CBE. And which conforms to our results of debt to equity ratio.
c. Equity Multiplier (EM) This ratio shows how many dollars of assets must be supported by each dollars of equity capital. The higher value of this ratio indicates signal for risk failure The analysis of equity multiplier further proves WB and NIB to be less risky and more solvent as compared to the rest of the peer groups. This result is consistent with our results found in DER and DTAR for WB and NIB. Not surprisingly, WB and NIB EM is exhibiting similar behaviour as of DER, which further verifies that relative to debt, equity base is increasing more in WB and NIB due to that they ranks the first two position respectively and the last position occupied CBE because of it involves in more risky and less solvent businesses.
d. Non-performing Loans to Total Loan (NPLTL) NPLTL ratio is one of the most important criteria to assess the quality of loans or asset of a commercial banks. It measures the percentage of gross loans which are doubtful in banks' portfolio. The lower the ratio of NPLTL, the better is the asset/credit performance for the commercial bank.  Vol.11, No.7, 2019

Figure 3.4 Non-performing loan to total
The above figure presented the trends for non-performing loan to total loan ratios. BOA demonstrated better management of its risk and solvency, and was able to get an average of non-performing loan to total loan ratios to the tune of 0.16%. This is least of all banks and thus BOA is ranked first and followed by UB with an average of 0.17%. The average of NPLTL ratios of WB is at 0.64% which is highest compared to other banks and is ranked last.
e. Overall ranking of risk & solvency measure The Group Ranking of all the selected banks under the Risk & Solvency parameter is presented in Table 3.11. The group ranking is based on the average of individual bank's risk and solvency sub-parameter ranks. The contribution of each bank for specific sub-parameter was converted into hundred percent primarily for not affecting the contribution of one specific-parameter by the other (to make each specific-parameter independent of each other), secondly to protect their contribution for the overall risk & solvency performance as well as the overall performance besides calculating the overall risk & solvency result conveniently. The table below shows the risk and solvency ratios by type of banks and the overall rank position of the banks regarding to risk and solvency.  Table above, NIB has the highest risk and solvency ratio and ranked first. NIB is followed by BOA, UB, and AIB occupying the second, third, and fourth position respectively. The last position is occupied by Commercial Bank of Ethiopia.
iv. Efficiency Ratio These ratios measure how effectively and efficiently the firm is managing and controlling its assets. A firm is technically efficient if it produces a given set of outputs using the smallest possible amount of inputs (Falkena et al, 2004). Outputs could be loans or total balance of deposits, while inputs include labour, capital and other operating costs.
a. Asset Utilization (AU) This ratio measures capability of firm to generate revenue with its asset. The high value of this ratio indicates the high productivity of firm's asset.    Table 3.12 depicted the total revenue to total assets ratios of the selected banks. The average of total revenue to total assets ratios of WB is highest at 7.81% amongst the group and thus ranks first and followed by NIB at 7.12% whereas the average of total revenue to total asset ratios of CBE is 5.46%, which is lowest and ranked least amongst the group.
a. Income to Expense Ratio (IER) Income to expense is the ratio that measures amount of income earned per dollar of operating expense. This is the most commonly and widely used ratio in the banking sector to assess the managerial efficiency in generating total income vis-à-vis controlling its total operating expenses. High IER is preferred over lower one. On the basis of seven year average total income to total operating expense ratio Commercial Bank of Ethiopia is at the top with 2.39 times followed by Wegagen bank and Awash International Bank with 1.77 times each and Bank of Abyssinia is at the last position with the average of 1.56 times.
b. Operating Efficiency (OE) Operating efficiency is the ratio that measures the amount of operating expense per dollar of operating revenue. It measures managerial efficiency in generating operating revenues and controlling its operating expenses. In other words, how efficient is the bank in its operations. Lower OE is preferred over higher OE. When the average OEs ratio of each bank over the study period is observed CBE has least average score which makes it better performer than its competitors. Similarly, WB & NIB stood 2nd and 3rd respectively. On the contrary, the OE status for BOA was on average around 89.23% during the study period which makes it the least performer.
c. Overall ranking of efficiency measure The Group Ranking of all the selected banks under the efficiency parameter is shown in Table 3.15. The group ranking is based on the average of individual bank's efficiency sub-parameter ranks, but from the sub-parameters OE was transformed into a meaningful form by taking the reciprocal (1/OE) for the purpose of comparison with AU and IER. Moreover, the contribution of each bank for specific sub-parameters was converted into hundred percent primarily for not affecting the contribution of one specific-parameter by the other (to make each specificparameter independent of each other), secondly to protect their contribution for the overall efficiency performance as well as the overall performance besides calculating the overall efficiency result conveniently. The table below shows the efficiency ratios by type of banks and the overall rank position of the banks regarding to efficiency.