An Alternative Ratio to Measuring a Bank’s Asset Quality

Dr. Gisanabagabo Sebuhuzu
Adventist University of Central Africa (AUCA), Rwanda gisanabagabo@yahoo.fr

Received June 6, 2019; Accepted June 13, 2019

Abstract: The benchmark that is internationally accepted in measuring asset quality using non-performing loans (NPLs) ratio is between 1 – 3 percent. In Rwanda it is 5 percent. This ratio might present deficiencies due to its computation whereby if the denominator increases more, the ratio can be in the acceptable range. For example when changes in NPLs and loan book are in the same proportion. This suggests that there is the stability of the bank as far as the asset quality is concerned, while the growing loan book is not of good quality. This paper examines limitations of the ratio of NPLs to report fairly the quality of the portfolio at risk. Based on a descriptive method of inquiry in analyzing the essence of this ratio and its limitations, this paper proposes an alternative ratio to measuring the asset quality of a bank that is the growth of non-performing loans in absolute value (gNPLs). In order to achieve the above, first, the study deduced the amount of NPLs from the audited financial reports for at least three banks operating in Rwanda. Second, it computed the growth rate of NPLs in absolute value for each bank year-to-year in the period covered by the study, and then contrasted findings to prove how the alternative proposed ratio which is the growth of NPLs displays better, the extent of how the loan portfolio quality changed year-to-year. Findings reveal that between 2010 and 2016, the growth of NPLs has fluctuated much higher between -67.4 percent and 320.6 percent whereas the ratio of NPLs has only fluctuated between 2.9 percent and 14.8 percent. Thus, the study recommends central banks to explore the use of the growth of NPLs along with the ratio of NPLs by banks in their reports about asset quality because this alternative ratio can send signals to managers, board members and regulator about the way the loan portfolio quality is being managed and take correctives measures on time, hence contributing to the sustainability of shareholders’ value