Question

Why it is not suitable to use ROA and ROE to measure the performances of financial institutions?

Answer 1

Answer:

ROA- Return on Asset is the return generated with the help of company's assets.

ROE- Return on equity is the profit/return generated on the shareholder's equity.

ROA and ROE are not suitable to measure the performance of financial institutions because financial institutions such as banks, NBFCs do not have more physical assets like non finance companies so return on asset is not suitable, on the other hand, banks and NBFCs have leverage and less equity so ROE is also not suitable.

ROA and ROE should not be used because banks are highly leveraged. Bank may have higher ROA but it will be on risky assets.

RAROC is used in financial institutions. RAROC is "Risk adjusted return on capital" that is calculated:

RAROC = Revenue-Operating cost-Expected loss / Risk based required capital