What Is Gross Spread Ratio?

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Gross spread ratio looks at the spread of interest between borrowing and lending. Banks make money by borrowing short-term money from depositors and then using these funds to make long-term loans to businesses, consumers and homeowners. One way to analyze gross profit rates of banks is to look at the spread between the loan rates and deposit rates. Further, through ratio analysis, you can use the gross spread ratio to determine the profitability, liquidity and leverage of a bank.

Spread

The spread is the difference between funded revenue as a percentage of earning assets such as loans and the value of the funds as a percentage of average paying funds such as depository accounts. Typically, a higher spread indicates a higher profit margin for the bank. Although you can gauge some future trends through ratio analysis, you cannot predict future variances. There is no such thing as a tool that can predict future deposits at a bank.

Ratio

The ratio can tell you the percentage of the total income earned by the bank before taxes. The ratio can also give you an idea of the turnover of the assets required to generate income and the returning net profit earned by the bank in comparison with the assets. However, you have to consider all the financial and non-financial assets and liabilities of the bank to accurately analyze the profitability of the bank.

Deposits

Banks have to follow significant rules and regulations regarding deposits made at their institutions. Banks have a fiduciary duty to make funds deposited into accounts available for withdrawal. This includes disclosure of the bank’s fund availability policies, interest paid on depository accounts and liabilities.

Interest Rate

Banks make money lending funds and charging an interest rate. By lending money at a specific interest rate, banks expose themselves to interest rate risk caused by changing market conditions. Changes in market interest rates can greatly affect the earnings potential of a bank. By changing its net interest income, other interest income and operating expenses, a bank can help control its earnings. A change in the market interest rate also can affect the value of the bank's assets and liabilities. The gross spread ratio analyzes deposits, interest rates, lending rates and borrowing to assess the profitability and effectiveness of the bank.

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References

  • "Business Ratios and Formulas: A Comprehensive Guide"; Steve M. Bragg; 2006
  • "Option Spread Trading: A Comprehensive Guide to Strategies and Tactics"; Russell Rhoads; 2011
  • "Principles of Finance"; Scott Besley and Eugene Brigham; 2008
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