In line of principle, banks are valued using the same valuation methods applied to non-financial companies. However, the specific economics of banks make some approaches more suitable than others, or require specific adjustments to reflect the peculiarities of the financial sector. Going forward we will assume that the reader is already familiar with the most common corporate valuation techniques – namely Discounted Cash Flow, Dividend Discount Model, and Multiples – as presented by the main finance and valuation textbooks. Our focus will be on the problems and solutions to be dealt with when such valuation models are applied to financial institutions. The chapter begins by highlighting what sets financial institutions apart in the realm of company valuation, and then presents, one by one, the main approaches used in practice.
5.1 WHY BANK VALUATION IS DIFFERENT
The nature, systemic importance, and complexity of banks' operations make them unique organizations. This is reflected in the peculiar financial structure of banks, which differs substantially from that of non-financial companies. There are at least three aspects of banks' financial structures that have an impact in terms of valuation.
First, banks are highly levered entities: an equity/total asset ratio as low as 5% is the norm rather than exception in the industry. For non-financial companies such degree of leverage is rare and sustainable only on a short-term basis (it is usually adopted in extraordinary ...