Table Of ContentPALGRAVE MACMILLAN STUDIES IN
BANKING AND FINANCIAL INSTITUTIONS
SERIES EDITOR: PHILIP MOLYNEUX
Valuing Banks
A New Corporate Finance Approach
Federico Beltrame
Daniele Previtali
Palgrave Macmillan Studies in Banking
and Financial Institutions
Series Editor:
Philip Molyneux
Bangor Business School
Bangor University
UK
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Federico Beltrame • D aniele Previtali
Valuing Banks
A New Corporate Finance Approach
Federico Beltrame Daniele Previtali
University of Udine Luiss Guido Carli University
Italy Rome , Italy
Palgrave Macmillan Studies in Banking and Financial Institutions
ISBN 978-1-137-56141-1 ISBN 978-1-137-56142-8 (eBook)
DOI 10.1057/978-1-137-56142-8
Library of Congress Control Number: 2016938714
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To Giorgio, Silva and Ivana
(Federico Beltrame)
To Virginia, Daniela and Antonio
(Daniele Previtali)
for their love and support
Fore word
W hy a new book on bank valuation? And why not a new book on fi rm
valuation? Maybe the answer is in the question itself, as sometimes
h appens, and, according to Beltrame and Previtali, this is the case. Of
course, there are many relevant issues in company valuation that are
worth discussing, from the general approach to more specifi c operational
techniques, such as cash fl ow identifi cation, discount rate setting, asset
appraisal, and so on. But this book focuses on the application of the
generally accepted valuation approaches to fi nancial institutions, not just
taking into consideration the general theory of fi rm valuation, but also
trying to ascertain whether such a theory works when it comes to banks.
Th e issue is not new or, if you prefer, it is rather an old one. So, why
are we still interested in it? From my point of view, the reason is that we
have not yet solved all the problems, so a generally accepted approach to
bank valuation is still some way off . As a matter of fact, both practitioners
and scholars have their own framework for bank valuation, even though
they often admit to a certain lack of accuracy when general v aluation
techniques are applied to fi nancial institutions. If we seek a concrete
demonstration of such inaccuracy, it is suffi cient to look at the huge
fl uctuations of bank share prices during the fi nancial crisis. One must
admit that the word “inaccuracy” is an understatement.
But what really diff ers between banks and other companies? What
makes fi nancial institutions so special as opposed to all other kinds of
vii
viii Foreword
fi rm? Most practitioners and scholars share the idea that banks are diff er-
ent from other fi rms in two main ways: the role and the nature of their
regulation—namely, capital requirements; and the role of debt—which is
not merely a funding instrument but, rather, is part of the products that
a bank sells. If we put these roles together, we conclude that the right side
of a bank’s balance sheet is so peculiar that, in order to evaluate a fi nancial
institution, we cannot simply apply the generally accepted methodolo-
gies. By the way, I would like to stress that, in turn, the diff erences in the
funding structure of banks refl ect the special nature of these fi rms. Th e
crucial point is that bank debt is the most common means of payment;
bank debt is money, not just a funding source, and this is also the reason
why regulation is so tough. Th e central role of banks in the modern
economy is of such great importance that governments and authorities
worry about banks’ soundness in order to protect deposits and to preserve
the stability of the overall economic system. Such a deep macroeconomic
peculiarity is relevant also from the microeconomic point of view, and
this is why the evaluation of banks remains an issue for practitioners and
academics.
Th e starting point of the authors is these diff erences, which they try to
overcome by attributing a specifi c value to the liabilities side. More
generally, the proposed methodology gives many diff erent answers to the
issue concerning bank valuation that the existing literature has consis-
tently stressed. Th e authors achieve this by using a new corporate fi nance
approach. I do not wish to anticipate the solutions they see, but I would
like to say something about it.
F irst, I share their technical approach with regard both to the capital
requirements issue and to the instrumental nature of debt. Th e aim of the
proposed model is to better quantify the cash fl ow that is to be put in the
classical discounted cash fl ow (DCF) models. Needless to say, the a ccurate
defi nition of the cash fl ows is crucial in order to obtain a correct measure
of a fi rm’s value. In this respect, the qualifi cation of bank debt not merely
as a funding instrument, but rather as an operating tool in the produc-
tion process of intermediation opens diff erent perspectives in the
construction of the model. It should be emphasized that the model is
coherent with all the prudential and accountancy rules usually adopted in
the banking sector, so the application of the model does not require any
Foreword ix
steps other than the ordinary reclassifi cation of the balance sheet and the
income statement. Th is is important because it allows the proposed
model to be compared with traditional techniques.
Th e book also off ers an interesting literature review that gives readers
the chance to refl ect on the various approaches usually applied in bank
valuation. It suggests that it may be useful to devote more studies to the
analysis of the eff ect of regulation on banks’ value. I refer particularly to
the eff ects of capital requirements on the appraisal exercise, where the
common praxis is to include in the free cash fl ow to equity only the excess
capital or, more generally speaking, only the amount of resources that
could be distributed to shareholders without notching the minimum
requirements set by the regulations. Th e assumption is easily understand-
able in the light of the fi nancial approach, which states that the value of
a fi rm, and even of a bank, is simply the present value of the future cash
fl ows from the investment. If, therefore, a bank is not able to distribute
any cash fl ow due to the necessity to maintain the required gearing ratio,
does it mean that it is worth zero or even below zero? In other words, does
it mean that the required equity of a bank is valueless? Of course, if we
adopt, for a while, a gone approach, it is evident that such equity is worth
the diff erence between the value of assets and liabilities. In an ongoing
approach, this value seems to disappear, even if it is the fundamental
engine of the banking activity. I feel further analysis and refl ection are
needed on this subject.
A nother intriguing point is the role of the interest rate in bank
valuation. As everybody knows, the discount rate is crucial even in the
valuation of other types of company, but its eff ect is limited to the area of
the determination of the present value of the expected cash fl ow. Every
change in the general level of the interest rate aff ects only the discount
factor and not future cash fl ows, at least directly. As far as banks are
concerned, interest rate fl uctuation infl uences both the returns and the
discount factor; signifi cantly, these two eff ects are in opposition to each
other. Here, we can see another positive aspect of the proposed model
because it makes possible the isolation of the eff ect of interest rate changes
on both the operating profi t and on the debt. Th is demonstrates that
banks’ goodwill depends heavily on their debts and, in turn, it underlies
the very nature of commercial banks (and not necessarily of every kind of
