Principles of Bank Valuation  747
on deposits or loans. But the taxation of the interest income that the mismatch 
generates has an impact on value, which should be included in the economic 
spread on loans. Note that the tax result on the maturity mismatch could be 
positive in the (unlikely) case that a bank’s loans have a shorter maturity than 
its deposits. The TMM (in millions of dollars) for ABC Bank’s loans in 2019 is 
calculated as follows:
TMM =
×
−
(
)
=
−
(
) =
T
L k
k
L
D
30
1 133 7
5 1
4 6
1 7
%( ,
. )
. %
. %
.
The after-tax economic spread on loans is then derived as:
SAT =
−
−
−
=
15 9 1
30
8 2
. (
%)
.
.
.
1 3
1 7
This number represents the dollar amount of value (in millions) created by 
ABC’s loan business. Along the same lines, we can define the economic spread 
for ABC Bank’s deposit products as well (see Exhibit 38.8). Our analysis ex-
plicitly includes the spread on deposits because banks (in contrast to indus-
trial companies) aim to create value in their funding operations. For example, 
ABC Bank created value for its shareholders in its deposit business in 2019 
because it attracted deposits at a 4.3 percent interest rate, below the 4.6 percent 
rate for traded bonds with the same high credit rating as ABC had.12
EXHIBIT 38.8  ABC Bank: Historical Economic Spread by Product Line
$ million
2015
2016
2017
2018
2019
Loans interest rate, %
7.0
7.0
7.0
6.5
6.5
Matched-opportunity rate (MOR), %
5.5
5.5
5.5
5.5
5.1
Loans relative economic spread, %
1.5
1.5
1.5
1.0
1.4
Loans book value1
 1,000.0 
 1,030.0 
 1,063.5 
 1,097.5 
 1,133.7 
Loans economic spread before taxes
 15.0 
 15.5 
 16.0 
 11.0 
 15.9 
Taxes on economic spread
 (4.5)
 (4.6)
 (4.8)
 (3.3)
 (4.8)
Tax penalty on equity and maturity mismatch
 (2.1)
 (3.1)
 (3.8)
 (4.5)
 (3.0)
Loans economic spread2
 8.4 
 7.8 
 7.4 
 3.2 
 8.2 
Deposits interest rate, %
5.0
4.8
4.7
4.5
4.3
Matched-opportunity rate (MOR), %
5.0
4.7
4.6
4.5
4.6
Deposits spread, %
–
–0.1
–0.1
–
0.3
Deposits book value1
 960.0 
 988.8 
 999.7 
 1,009.7 
 1,043.0 
Deposits economic spread2
–
 (0.7)
 (0.7)
–
 2.2 
1 Beginning of year.
2 After taxes.
12 Note that the spread for deposits does not include a tax charge for maturity mismatch and equity risk 
capital; these are included in the spread for loans.

748  Banks
When comparing the spread across ABC product lines over the past few 
years, we can immediately see that most of the value created comes from 
its lending business. In fact, ABC was not making any money on its deposit 
funding from 2015 to 2019, as shown by the zero or negative spreads in 
those years.
From our calculations of the economic spreads of the two businesses, it 
is possible to rearrange the value driver tree from the equity DCF approach 
shown previously in Exhibit 38.5. In the revised value driver tree shown in Ex-
hibit 38.9, the key drivers are virtually identical but highlight some important 
messages about value creation for banks:
• Interest income on assets creates value only if the interest rate exceeds 
the cost of capital for those assets (i.e., the matched-opportunity rate) by 
more than the taxes on any maturity mismatch.
• Changes in the capital ratio affect value creation only through the tax 
penalty on equity.
• Growth adds value only if the economic spread from the additional 
product sold is positive and sufficient to cover any operating expenses.
Figure 38.9  Generic Value Driver Tree for Retail Banking: Economic Spread
Spread liabilities1
Value creation
Operating 
expenses1
Growth
Spread assets1
Tax penalty
Interest rate 
liabilities1
Interest rate 
assets1
Additions to loan
loss provisions1
Liabilities
Assets
Cost/income
1
1
2
3
4
5
6
7
2
7
3 
6
MOR liabilities
Equity
Tax rate
MOR assets
5 
Capital ratio
4
Key value drivers
Interest rates on 
products
Volumes: Book 
values of assets and 
liabilities outstanding
Cost-to-income 
ratio: Operating costs 
of business relative to 
net interest income
Capital ratio: Equity 
requirements for 
assets outstanding
Cost of capital: Cost 
of capital (MOR) 
across product lines
Growth: Growth of 
assets and liabilities
Loan losses: 
Expected future 
losses on loans 
outstanding
1 After taxes.