AHP Based Model for Bank Performance Evaluation and Rating

Abstract

Summary: This paper presents a multicriteria model for the bank performance evaluation. The model is based on the AHP method (Analytical Hierarchy Process), and it enables the integration of the quantitative data (measured by selected financial ratios) and qualitative data by which the bank features and some internal and external environment factors are described. The financial ratios used in the model are selected in accordance with the established results of the research on their correlation with different levels of the bank’s efficiency, measured by means of Data Envelopment Analysis method. In the qualitative analysis, such features of the bank are used, which are usually included in specific analyses of the qualitative rating of banks, as well as in SWOT analysis, which is also used in the analysis of the business potential of a bank. The result of the evaluation of the sample of the Croatian banks by this model is presented. There are various motives to support the efforts of searching for the best method of bank performance evaluation. Managing the financial system of a country requires the kind of methods which enable the financial institutions to recognise the management problems on time so that steps for the protection of citizens and the whole system can be undertaken, since the level of problems resulting from poor bank management threaten the whole financial system of the country. From an individual bank’s point of view, the interest of the bank for its efficient operation finds it important to be able to compare with the competitive banks and identify the causes of its (in)efficiency. Bank performance evaluation is of great importance for individuals, due to their need to protect against banking with a risk-running bank or due to the speculative motives linked to the activities on the capital market. Bank performance evaluation is traditionally based on the analysis of financial ratios. However, regardless of how many ratios are being used, a model that would fully satisfy the analysis of needs and bank operations’ efficiency evaluation has not been developed yet. For this reason, the financial ratio analysis is complemented with different quality evaluations, with features such as management quality, equity structure, competitive position and others to be included into the final evaluation. The model presented in this paper has in the first place been developed with the purpose to compare (rank) the Croatian banks. The experience in either the Croatian banks’ performance evaluation or their rating is not very rich. Traditionally, in the specialist literature the banks are annually rated according to the value of their assets, while the more complex models, which would make their multi-criteria