Lesson A3.1 · 1 of 5 · Special sectors
How to analyse a bank: net interest margin, NPLs, CET1 and P/B
You do not use EBITDA or net debt to analyse a bank, because debt is its raw material. Instead you look at four things: what it earns on lending (net interest margin), what it loses on bad loans (cost of risk, NPLs), how much capital it holds against risk (CET1) and the return on that capital (ROE), which you set against P/B.
Terms in this lesson
- ROE
- How much profit the company makes from shareholders' money.
- P/B
- The share price compared with the company's value on its balance sheet.
- Book value
- What would be left for shareholders after paying all debts, according to the balance sheet.
- Leverage
- You invest more than you have, with money borrowed from your broker.
The key bank ratios: net interest margin and cost:income
In the lesson on company debt you saw why net debt and EBITDA do not suit banks, and in the one on ROE, why a bank’s ROE comes naturally from leverage. Here you go further and read a real bank one ratio at a time. The example is Lloyds Banking Group and its results for 2025.
| Measure | Lloyds, 2025 | What it shows |
|---|---|---|
| Profit after tax | £4,757m | the year’s result |
| Banking net interest margin | 3.06% | what it earns between interest received and paid |
| Cost:income ratio | 58.6% | how much of income goes on costs |
| Underlying impairment charge | £795m | new provisions for bad loans |
| Asset quality ratio | 0.17% | the impairment charge as a share of loans |
| CET1 ratio | 14.0% | core capital against risk-weighted assets |
| Return on tangible equity | 12.9% | profit on equity, excluding goodwill and intangibles |
Lloyds Banking Group, 2025 results, published on 29 January 2026.
Definition
What is net interest margin (NIM)?
Net interest income divided by the assets that earn interest.
The bank earns interest on loans and government bonds and pays interest on deposits and on its own borrowing. The difference is net interest income. Banks report the margin on interest-earning assets; if a bank does not give the figure, you can approximate it on average total assets. Lloyds reported net interest income of £13,230m for 2025 and a banking net interest margin of 3.06%, which it works out on its average interest-earning banking assets.
Lloyds Banking Group, 2025.
The margin moves with interest rates. When rates rise, variable-rate loans quickly earn more, while deposits usually reprice more slowly. When rates fall, the effect goes into reverse. So a very wide margin in a year of high rates is not necessarily the bank’s own achievement.
Definition
What is the cost:income ratio?
Operating costs divided by total income.
It shows how much of each pound of income goes on staff, branches, technology and levies. The lower it is, the more efficient the bank. Lloyds reported 58.6% for 2025, or 53.3% excluding remediation (charges for putting right past failings). When you compare two banks, check that both figures include the same items.
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Create a free accountNon-performing loans, cost of risk and coverage
Definition
When does a loan become non-performing?
When the borrower is more than 90 days behind, or is unlikely to pay.
That is how ECB Banking Supervision defines it: a loan becomes non-performing when there are signs the borrower is unlikely to repay it, or when more than 90 days have passed without the agreed instalments being paid. The NPL ratio is the share of all loans in that position.
The year’s new provisions divided by average loans. Lloyds calls it the asset quality ratio: 0.17% in 2025, on an impairment charge of £795m.
How many loans are already in trouble. It usually rises with a lag, after the economy slows.
Provisions already made, divided by non-performing loans. The higher it is, the less a wave of defaults hurts future profit.
Lloyds had an expected credit loss allowance of £3,353m at the end of 2025, against £481.1bn of underlying customer loans: about 0.70% of the book. Set a figure like this against the bank’s own history and against its peers, not against an absolute benchmark.
A bank’s capital: CET1 and the Basel III requirements
Definition
What is the CET1 ratio?
The highest-quality capital divided by risk-weighted assets.
CET1, common equity tier 1, is mainly shareholders’ capital and retained profit, after certain deductions. Risk-weighted assets give each asset a weight according to how risky it is: a loan to a company usually weighs more than a government bond. The rules come from the Basel Committee, hosted by the Bank for International Settlements (BIS), and each country’s regulators apply them.
On top of these minimums, regulators can set a countercyclical buffer of between 0 and 2.5% of risk-weighted assets, plus requirements specific to each bank. A bank that dips into its buffers faces limits on distributions such as dividends. Lloyds put its total regulatory CET1 requirement at about 12% of risk-weighted assets; it reported a CET1 ratio of 14.0% at the end of 2025 and aims to run at about 13.0%, including a management buffer of about 1%.
ROE and P/B at banks: why P/B ≈ ROE ÷ cost of equity
Definition
Where does the link between P/B and ROE come from?
With no growth, P/B = ROE ÷ cost of equity.
Take a bank that does not grow and pays out all its profit. Its value to shareholders is annual profit divided by the return they require (the cost of equity), as in the lesson on interest rates and the stock market. Profit is ROE × book value. Divide both sides by book value and you get P/B = ROE ÷ cost. With growth g, the formula becomes P/B = (ROE - g) ÷ (cost - g). So a bank earning more than its cost of equity “deserves” to trade above book value, and one earning less, below it. Banks often quote tangible book value instead, leaving out goodwill and intangibles; Lloyds’ was 57.0p per share at the end of 2025.
- ROE 18%, cost 12%P/B = 1.5: each pound of capital earns more than shareholders require.
- ROE 12%, cost 12%P/B = 1.0: the bank merely covers its cost of capital.
- ROE 9%, cost 12%P/B = 0.75: capital left in the bank earns less than shareholders require.
Lessons are educational. They are not a recommendation to buy or sell. Investing involves risk and you can lose money. Sources: Lloyds Banking Group, 2025 results (29 January 2026, FCA National Storage Mechanism): profit after tax £4,757m, net interest income £13,230m, banking net interest margin 3.06%, cost:income ratio 58.6% and 53.3% excluding remediation, underlying impairment charge £795m, asset quality ratio 17 basis points, return on tangible equity 12.9%, CET1 ratio 14.0%, total CET1 requirement c.12% of risk-weighted assets, CET1 target c.13.0% including a management buffer of c.1%, underlying customer loans £481.1bn, expected credit loss allowance £3,353m, tangible net assets per share 57.0p; ECB Banking Supervision, “What are non-performing loans?”; Basel Committee (BIS), Basel Framework RBC20.1 (4.5%, 6%, 8%) and RBC30.2 and RBC30.9 (2.5% conservation buffer, countercyclical buffer of 0-2.5%). The loan-loss allowance as a share of loans and the P/B figures are our calculations.