Financials sector: banks, insurers and what to watch

The financials sector includes companies whose business is money itself: banks that take deposits and lend, insurers that pool risk, asset managers, exchanges, brokers and payment businesses. Their financial statements look different from those of other companies, because debt and cash are raw materials and not just financing. That means many familiar ratios mislead when applied to them, and a different toolkit is needed.

What is inside the sector

Real estate was part of financials until it became a separate sector in 2016. Payment networks such as Visa and Mastercard moved into financials in 2023 from information technology. See the 11 GICS sectors for the full map.

How banks earn money

A bank's core profit is net interest income: the interest it earns on loans and securities minus the interest it pays on deposits and borrowing. Dividing by earning assets gives the net interest margin.

Net interest margin = net interest income / average earning assets
Efficiency ratio = non-interest expense / total revenue

Example (illustrative numbers). A bank has $100 billion of earning assets and earns net interest income of $3 billion. Its net interest margin is 3.0%. If it has $2 billion of fee income and $3 billion of non-interest expense, revenue is $5 billion and the efficiency ratio is 3 / 5, or 60%. A lower efficiency ratio is better.

Banks then set aside provisions for credit losses, money reserved for loans that may not be repaid. Their results depend on the interest rate environment, as described in interest rates and the Federal Reserve, and on credit quality, which typically deteriorates when the economy weakens. Regulators require banks to hold minimum capital. A widely watched figure is the Common Equity Tier 1 (CET1) ratio, which compares high-quality capital with risk-weighted assets. Larger US banks also face regular supervisory stress tests.

How insurers earn money

Insurers collect premiums up front and pay claims later. In the gap, they invest the premiums, a pool often called float. Property and casualty insurers are judged on the combined ratio:

Combined ratio = loss ratio + expense ratio

Example (illustrative numbers). If an insurer pays out claims equal to 65% of premiums and spends 30% on expenses, its combined ratio is 95%. A figure below 100% means an underwriting profit of 5 cents per premium dollar, before investment income. If a major catastrophe lifts claims to 80%, the combined ratio becomes 110%, an underwriting loss. Life insurers have different drivers, notably investment returns and the long-term match between assets and obligations.

Metrics that fit financials

• Price-to-book and price-to-tangible-book. Bank assets and liabilities are mostly financial and carried near market value, so book value is a meaningful anchor. Tangible book excludes goodwill and intangibles. See price-to-book ratio.
• Return on equity. Profit relative to shareholders' equity is the standard test of how well capital is used. See return on equity.
• Net interest margin and efficiency ratio for banks, and combined ratio for property and casualty insurers.
• Capital ratios and credit metrics. CET1, the share of loans past due, and reserve levels.
• Growth in fees and assets under management for asset managers.
• Price-to-earnings and dividend payout. These remain useful, especially for mature companies.

Why standard ratios mislead

EV/EBITDA and free cash flow are poorly suited to banks. Interest is their operating cost, not a financing choice, and deposits behave like debt that funds the business. A bank's debt-to-equity ratio is naturally high, because leverage is the business model, and comparing it with an industrial company's tells you little. Operating cash flow can swing with loan activity and trading, unrelated to underlying profitability. Use sector-appropriate measures and compare with other financial companies.

Risks and limits

• Leverage. Small asset losses can wipe out a large part of equity.
• Credit cycles. Loan losses cluster in recessions.
• Interest rate sensitivity. The effect depends on how assets and liabilities reprice, and results differ by bank.
• Funding and liquidity. Confidence matters, and funding can disappear quickly in stress.
• Regulation. Capital rules and policy changes shape returns.
• Opacity. Loan portfolios and trading positions can be hard for outsiders to assess.
• Catastrophe and reserve risk for insurers. Reported results can be revised when reserves prove too low.

Where to see it on StocksXray

StocksXray ranks every metric as a percentile within the company's own sector, so a bank is compared with other financials, not with software or retail. Check the fundamentals checklist and peer list on the stock page with the sector-specific caveats above in mind, and visit the financials sector page for the group.

Key takeaways

• Financials earn money from spreads, premiums and fees, and not from selling products.
• Banks are read through net interest margin, efficiency, credit quality, capital and book value; insurers through the combined ratio and float.
• EV/EBITDA, free cash flow and debt-to-equity are poor fits for banks.
• Leverage makes the sector sensitive to credit cycles and funding confidence.
• Always compare with financial peers.