The appropriate benchmarks for tracking banking sector performance depend on the type of banking. For instance, commercial-only banks can be evaluated very differently than retail-only banks. For smaller savings and loans institutions, standard benchmarks include net interest margins, the ratio between equity and total assets, and accounts receivable collection ratios. Huge multinational firms should be tracked with profitability, average net asset values and market indexes designed to track the overall performance of one sector.
Other benchmarks can be more specifically selected through exchange-traded funds (ETFs) or mutual funds. It’s likely that ETFs can provide a better overall benchmark for a whole sector than mutual funds.
Sector Benchmarking
The term “benchmark” is thrown around a lot in financial literature, but it doesn’t always mean the same thing in every possible situation. In corporate governance and business consulting, for instance, benchmarking is the process by which one company tracks the performance of and tries to emulate a leading competitor. Investors might establish benchmarks as goals within the context of a long-term financial strategy.
Sector benchmarking is different. Investors and analysts look to sector benchmarks as a reference point. They can compare the performance of their portfolios or a specific stock against the generalized performance of an entire industry.
In terms of banking sector benchmarking, this means tracking market indexes tied to the financial services sector. Industries such as banking, insurance and others are likely to be included.
A banking sector index is designed to track the stock market performance of major banking companies. The Dow Jones has specific subindexes (such as the U.S. Financials Index) based on companies with large market capitalizations that are traded on the New York Stock Exchange.
Other investors avoid weighted benchmarks and track the average fundamentals of publicly reporting companies within a specific sector.
Fundamentals of Banking
Banks are not all homogeneous, so each fundamental metric reflects better on some firms over others. Most banks are concerned with their net interest margins. Fundamental investors should also look at average capitalization ratios.
A sector is likely to correlate more consistently with broad economic performance than individual firms do. Investors should also keep an eye on interest rate policy, Federal Reserve action and the value of high-priced assets,
Equities as Benchmarks
ETFs are meant to mirror or closely mirror the performance of indexes. Popular ETFs that track the banking sector include the Financial Select Sector SPDR, the SPDR S&P Bank ETF and the Nasdaq American Banking Association Community Bank Index Fund.
The American banking sector could just as well be benchmarked with a mutual fund comprised of the five largest banks: Bank of New York Mellon Corporation, Wells Fargo, Citigroup Inc., Bank of America and JP Morgan Chase & Company.