Valuation of Banks

Sidsel Dreyer & Pauli Nielsen-Englyst

Student thesis: Master thesis


The purpose of this master thesis is to develop a framework that can be used to determine the value of a bank’s equity. This master thesis can be divided into two parts where the first part develops a framework to use upon Danish banks and the second part consists of a practical case study where the framework is applied upon Djurslands Bank A/S. Inordertodevelopthisframework,informationregardingabank’sbusinessmodelandfinancials has been collected. Within this information, it was found that the Danish banking industry in general is a highly regulated industry and depends a lot on the general market conditions. The regulations put limits on how much risk the banks are allowed to undertake and thereby how fast they can grow. These regulations are imposed with the purpose of ensuring financial stability and thereby avoiding another financial crisis. In addition to this, it was found that a bank’s financial statements differ significantly from non-financial companies’. One of the major differences is that non-financial companies use debt as a way of raising capital where banks on the other hand both use it as a way to raise capital but also to fund their loans to customers. This causes an issue in relation to the valuation since some of the present value approaches require a distinction between operating and financing activities. Since this distinction is not a possibility in regards to banks, we have to use a direct present value approach, where only the equity holders have claim on the cash flows. The final present value approach ended up being a free cash flow to equity model (FCFE) but it has been modified in order to suit banks better. This modification included a redefinition of reinvestments since these are different for banks from non-financial companies. Unlike nonfinancial companies, banks mostly reinvest in their regulatory capital. They do that in order to be able to grow their risk carrying assets, which consist of their loans. This reinvestment in regulatory capital has been incorporated into the FCFE model so these are taking into account whentheFCFEarecalculated. Inextenttothispresentvalueapproach,differentguidelinesare set upon how to analyze a bank?s value drivers. Furthermore, two multiples are found suitable for banks as well and these are included in the framework to cross-examine the estimated value found by using the FCFE method. This framework was afterwards used upon Djurslands Bank A/S to illustrate whether it is suitable in a practical case study. It is found that the framework is appropriate to valuate banks but as with other valuation methods, there is a relatively high level of uncertainty associated with it due to subjective assumptions about the future.

EducationsMSc in Auditing, (Graduate Programme) Final ThesisMSc in Accounting, Strategy and Control, (Graduate Programme) Final Thesis
Publication date2018
Number of pages143
SupervisorsOle Vagn Sørensen