Bank Performance Risk

To manage performance risk, banks must maintain stable and diversified income sources, control costs, and maintain robust risk management practices to minimize their credit costs. In this short video, GICP Trainer Jo Lock gives an overview of performance risk.

Read the transcript

Hello and welcome. Today, I’d like to talk to you about bank performance risk, and specifically how it’s reflected in the income statement—an essential document for understanding a bank’s financial health.

First, let’s define performance risk. In the context of banking, performance risk is the chance that a bank won’t achieve its expected financial results. This can impact profitability, shareholder value, and, ultimately, the bank’s ability to meet its obligations.

Performance risk is important to credit professionals because it signals how vulnerable a bank might be to changes in its operating environment or internal mis-steps.

To understand the drivers of performance risk, check out our other videos on bank financial and business risk.

Now, let’s break down how this risk shows up in the income statement, starting with income streams—the sources of a bank’s revenue.

The most significant income stream for many banks is net interest income. This is the difference between the interest a bank earns from loans and investments and the interest it pays out to depositors and other lenders. Net interest income can be affected by shifts in interest rates, changes in the demand for loans, and the quality of the bank’s lending portfolio. If interest rates fall or loan demand weakens, or if more borrowers default on their loans, the bank’s net interest income—and therefore its overall performance—can suffer.

Another important source of revenue is fee and commission income. Banks earn these fees by providing services such as account management, transaction processing, and advisory work. The risks here include increased competition, regulatory changes that cap fees, or changes in customer behaviour. If fewer customers use these services, or if new regulations restrict fee levels, performance risk will rise because these revenue streams are less reliable.

Trading income and investment gains can also be significant, especially for larger banks. These come from buying and selling financial instruments in the financial markets. However, this type of income is often volatile, sometimes incredibly so. Market downturns, economic uncertainty, or poor trading decisions can quickly turn anticipated gains into losses, increasing the bank’s performance risk.

Other operating income is a category in the income statement that captures various sources of revenue that aren’t part of a bank’s core lending or fee business. These activities are often linked to specific services or products that banks offer in addition to traditional banking such as insurance or selling assets or subsidiaries or one-off gains. These sources can be unpredictable and often do not recur. They can be influenced by market demand and the bank’s ability to compete effectively. In short, these income sources are not guaranteed—they go up or down depending on what customers want and how well the bank competes in the market. This is why monitoring market demand and staying competitive are important for managing performance risk.

Let’s move to costs—the money a bank spends to keep its operations running.

Operating expenses, such as staff salaries, rent, technology, and administrative costs, need to be tightly managed. If these costs rise faster than income, profit margins are squeezed. Inefficiencies or uncontrolled expansion can exacerbate performance risk.

Impairment charges and provisions are another critical item. These are funds set aside for potential loan losses or credit costs. If borrowers struggle to repay during an economic downturn, impairment charges go up, cutting into profits and signalling increased risk.

Interest expense is the cost of funding—what the bank pays for deposits and borrowings. If the bank relies on expensive funding sources or if market interest rates increase, these costs can surge.

Depreciation and amortization are ways banks show the gradual cost of using their assets. When banks invest heavily in new equipment, technology, or buildings, these costs rise in the short term and can reduce the bank’s reported profits, even though the cash was spent earlier. For credit professionals, it’s important to understand these costs, as they can affect how profitable a bank looks in the short term after major investments.

And finally, tax expense can fluctuate, sometimes unexpectedly, due to changes in tax laws or liabilities.

To manage performance risk, banks must maintain stable and diversified income sources, control costs, and maintain robust risk management practices to minimize their credit costs.

The income statement is like a window into the bank’s financial health. By understanding the details—how income is earned, how costs are managed, and what risks are present—you can make informed decisions about the bank’s stability today and its ability to succeed tomorrow. This is essential for credit professionals who need to judge the reliability and future prospects of the banks they work with.

Thank you for listening.