Valuation, 7th Edition

38Banks

Banks are among the most complex businesses to value, especially from the outside in. Published accounts give an overview of a bank’s financial performance but often lack vital information about its underlying economics, such as the extent of its credit losses or any mismatch between its assets and liabilities. Moreover, banks are highly levered, making bank valuations even more contingent on changing economic circumstances than are valuations in other sectors. Finally, most banks are in fact multibusiness companies, requiring separate analysis and valuation of their key business segments. So-called universal banks today engage in a wide range of businesses, including retail and wholesale banking, investment banking, and asset management.

In the view of some academics, managers, and regulators, the size, complexity, and lack of transparency of universal banks in the United States and Europe has led to undesirable systemic risks, among them that some banks have become “too big to fail.”¹ During the 2008 credit crisis, the threat of collapse by some large universal banks led governments to bail out these institutions, triggering an ongoing debate about whether such institutions should be split into smaller and separate investment and commercial banks.²

This chapter provides a general overview of how to value banks and highlights some of the most common valuation challenges peculiar to the sector. First, it discusses the economic fundamentals of banking and trends in ...