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Barclays PLC (LON:BARC) is a large, commercial bank with a market capitalisation of UK£27b. The biggest risk most large banks face is credit risk, measured by the level of bad debt it writes off. During the Global Financial Crisis, large financial institutions with commercial banking arms lost billions of dollars in equity due to their lending portfolios’ exposure to the turbulent credit market. This led to investors losing trust in these once stable financial stocks. Since the level of risky assets held by Barclays impacts its cash flow and therefore the attractiveness of its stock as an investment, I will take you through three metrics that are insightful proxies for risk.
See our latest analysis for Barclays
What Is An Appropriate Level Of Risk?
Barclays is considered to be in a good financial shape if it does not engage in overly risky lending practices. So what constitutes as overly risky? Loans that cannot be recuperated by the bank, also known as bad loans, should typically form less than 3% of its total loans. Bad debt is written off as expenses when loans are not repaid which directly impacts Barclays’s bottom line. With a ratio of 2.55%, the bank faces an appropriate level of bad loan, indicating prudent management and an industry-average risk of default.Does Barclays Understand Its Own Risks?
Barclays’s understanding of its risk level can be estimated by its ability to forecast and provision for its bad loans. If it writes off more than 100% of the bad debt it provisioned for, then it has inadequately estimated the factors that may have added to a higher bad loan level which begs the question – does Barclays understand its own risk? With a bad loan to bad debt ratio of 77.55%, Barclays has under-provisioned by -22.45% which is below the sensible margin of error, illustrating room for improvement in the bank’s forecasting methodology.
How Big Is Barclays’s Safety Net?
The nature of Barclays’s’ business involves lending out borrowed money. Customer deposits are the least risky form of borrowing as they are less volatile in terms of interest rate paid and amount available.
Generally, the higher level of deposits a bank retains, the less risky it is deemed to be.
Barclays’s total deposit level of 36% of its total liabilities is below the sensible margin for for financial institutions which generally has a ratio of 50%. This means the bank’s safer form of borrowing makes up less than half of its liabilities, indicating riskier operational activity.
Next Steps:
Relative to the liabilities of the company, Barclays’s safer form of borrowing is unenviably low. Also its cash flow could be negatively impacted by its below-average bad debt management. These risk metrics suggest there is room for improve in terms of its operational risk management to increase investors’ conviction in the business. We’ve only touched on operational risks for BARC in this article. But as a stock investment, there are other fundamentals you need to understand. There are three relevant aspects you should look at:
- Future Outlook: What are well-informed industry analysts predicting for BARC’s future growth? Take a look at our free research report of analyst consensus for BARC’s outlook.
- Valuation: What is BARC worth today? Has the future growth potential already been factored into the price? The intrinsic value infographic in our free research report helps visualize whether BARC is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.