A risk The Royal Bank of Scotland Group plc (NYSE:RBS) faces as a bank is bad loans, also formally known as “credit risk”. With a $49.45B market capitalisation, it falls in the large, commercial bank category. In the last recession, large banks like JP Morgan Chase, Bank of America and Wells Fargo Bank lost billions of dollars in shareholder equity as their risky lending portfolios were exposed to a tumultuous credit market. Investors lost confidence in what were once considered safe and stable stocks. Levels of bad debt and liabilities can be useful insights into Royal Bank of Scotland Group’s engagement with risky lending practices and operational prudency. Today we will talk about some important bank-specific metrics to better understand financial stock investments before taking the plunge. View our latest analysis for Royal Bank of Scotland Group
What Is An Appropriate Level Of Risk?
Royal Bank of Scotland Group is engaging in risking lending practices if it is over-exposed to bad debt. Loans that cannot be recovered by the bank are known as bad loans and typically should make up less than 3% of its total loans. When these loans are not repaid, they are written off as expenses which comes out directly from Royal Bank of Scotland Group’s profit. With a ratio of 2.77%, the bank faces an appropriate level of bad loan, indicating prudent management and an industry-average risk of default.
Does Royal Bank of Scotland Group Understand Its Own Risks?
The ability for Royal Bank of Scotland Group to forecast and provision for its bad loans accurately serves as an indication for the bank’s understanding of its own level of risk. If it writes off more than 100% of the bad debt it provisioned for, then it has poorly anticipated the factors that may have contributed to a higher bad loan level which begs the question – does Royal Bank of Scotland Group understand its own risk?. With an extremely low bad loan to bad debt ratio of 42.44%, Royal Bank of Scotland Group has significantly under-provisioned by -57.56% which is well below the appropriate margin of error. This may be due to a one-off bad debt occurence or a constant underestimation of the factors contributing to its bad loan levels.
Is There Enough Safe Form Of Borrowing?
Royal Bank of Scotland Group profits from lending out its various forms of borrowings and charging interest rates. Deposits from customers tend to carry the lowest risk due to the relatively stable interest rate and amount available. As a rule, a bank is considered less risky if it holds a higher level of deposits. Since Royal Bank of Scotland Group’s total deposit to total liabilities is within the sensible margin at 56.40% compared to other banks’ level of 50%, it shows a prudent level of the bank’s safer form of borrowing and an appropriate level of risk.
Now that you know to keep in mind these risk factors when putting together your investment thesis, I recommend you check out our latest free analysis report on Royal Bank of Scotland Group to see its growth prospects and whether it could be considered an undervalued opportunity.
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The author is an independent contributor and at the time of publication had no position in the stocks mentioned.