ANALYSIS OF THE BALANCE SHEETS OF COMMERCIAL BANKS

1
ANALYSIS OF THE BALANCE SHEETS OF COMMERCIAL
BANKS

• AD-477 BANK MANAGEMENT
• InstructorBülent Senver

2
BALANCE SHEETANALYSIS

• OF
• COMMERCIALBANKS

3
ANNUAL REPORT

• OF
• BANKS

4
ANNUAL REPORT

• 1. AUDITORS REPORT (AR)
• 2. FINANCIAL STATEMENTS (F/S)
• 3. NOTES TO F/S

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AUDITORS REPORT

• INDEPENDENT
• AUDITORS REPORT

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INDEPENDENT AUDITORS REPORT

• 1.What is done ?
• 2.What is audited ?
• 3.What is the auditors managements
  responsibility ?
• 4.Audit is done based on what standard ?
• 5.Auditors opinion based on IAS

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WHAT IS AUDITED ?

• We have audited
• 1. The Balance Sheet
  as of Dec31 1998 and 2. Statement of
  Income
• 3. Statement of Shareholders 4.
  Statement of Cash Flows
  for the year then ended

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HOW IS THE F/S AUDITED ?

• We conducted our audit in accordance with
  International Standards on Auditing (ISA)
• We plan perform the audit to obtain reasonable
  assurance that F/S are free of material
  misstatement.

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HOW IS THE F/S AUDITED ?

• An audit includes assessing the accounting
  principles used significant estimates made by
  management,
• as well as evaluating the overall F/S
  presentation.
• We believe our audit provides a reasonable basis
  for our opinion.

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AUDITORS OPINION

• In our opinion, the F/S referred to above present
  fairly, in all material respects, the financial
  position of A Bank the results of its
  operations, changes in its cash flows for the
  year then ended,
• in accordance with International Accounting
  Standards.
• Arthur Andersen Co

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FINANCIAL STATEMENTS

• OF
• COMMERCIAL BANKS

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FINANCIAL STATEMENTS

• 1. BALANCE SHEET
• 2. STATEMENT OF INCOME
• 3. STATEMENT OF SHAREHOLDERS EQUITY
• 4. SOURCES USES OF FUNDS STATEMENT

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B/S ANALYSIS DEPENDS ON

• Available Data
• Standard Reporting Practice
• Use of Internationally Accepted Accounting
  Standards
• Use of Internationally Accepted Auditing
  Standards
• Use of External Internal Audit Practice

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BALANCE SHEET SHOWS

• The Financial Position of a Bank

• As at a specific date.
• As of Dec. 31,1998

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BALANCE SHEETEQUATION

• 100
• ASSETS
• Equals

• 100
• LIABILITIES
• Plus
• SHAREHOLDERSEQUITY

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BALANCE SHEET Assets

• Liquid Assets 150
• Loans 400
• Marketable Securities 200
• Investment Securities 50
• Fixed Assets 100
• Accrued Interest 70
• Other Assets 80
• Total Assets 1050

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BALANCE SHEET Liabilities

• Deposits 400
• Bank Borrowings 150
• Accrued Expenses 100
• Other Liabilities 80
• Bonds Issued 70
• Shareholders Equity 250
• Total Liabilities S/HE 1050
  

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SHAREHOLDERS EQUITY

• Share Capital 100
• Legal Reserves 30
• Retained Earnings 50
• Revaluation Surplus 20
• Share Premiums 10
• Net Income 40
• Total S/H Equity 250

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ASSET VALUATION

• GAAP IAAP
• Generally Accepted Internationally Accepted
  Accounting Principles

• LOWER OF
• COST OR
• MARKET

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ASSET CLASSIFICATION
21
LIABILITY CLASSIFICATION
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BALANCE SHEETDOES NOT SHOW

• Interest Rates
• Interest Sensitivity
• Due Dates
• Foreign Currencybreakdown
• Collateral

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STATEMENT OF INCOMESHOWS

• The results of operations of a bank.

• For the period between two dates.
• For the year endedDec. 31 , 1998

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NET PROFIT
25
TOTAL INCOME
26
NET INTEREST INCOME
27
NET INTEREST INCOME
28
NET NON-INTEREST INCOME
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STATEMENT OF INCOME

• Interest Income
  1000
• Interest Expense
  (700)
• Net I.Income
  300
• Non Interest Income 220
• Operating Expenses (450)
• Pre-Tax Profit
  70
• Tax Provision
  (30)
• Net Income
  40

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ANALYSIS OF PROFIT
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BANKING

• RISKS

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BANKING RISKS

• C AMEL
• A
• M
• E
• L

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CAMEL

• Capital Adequacy

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CAMEL

• Asset Quality

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CAMEL

• Management Quality

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CAMEL

• Earnings Efficiency

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CAMEL

• Liquidity Risk

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CAMEL RISKS

• Capital Adequacy
• Asset Quality
• Management
• Earnings
• Liquidity

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BANKING RISKS

• 1.2.3.4.5.CAMEL
• 6. Credit Risk
• 7. Interest Rate Risk
• 8. Interest Rate Sensitivity Risk
• 9. Foreign Exchange Availability Risk
• 10. F/X Position Risk

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BANKING RISKS

• 11. Accounting Reporting Risk
• 12. Computer Risk
• 13. Capital Market Operations Risk
• 14. Money Market Operations Risk
• 15. Country (Sovereign) Risk
• 16. Pricing Risk

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BANKING RISKS

• 17. Theft Risk
• 18. Fraud Defalcations Risk
• 19. Natural Disasters
• 20. Strategic Risk
• 21. Reputation Risk
• 22. Market Risk
• 23. Fiduciary Risk
• 24. Transaction Risk
• 25. Regulatory / Compliance Risk
• 26. Large Loans / Deposits Risk
• 27. Concentration Risk

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RATIO ANALYSIS

• Numerator
• ______________________
• Denominator

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RATIO ANALYSIS

• Balance Sheet__________________Balance Sheet

• Income Statement________________Balance Sheet

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RATIO ANALYSIS

• What is the
• LEVEL ?

• What is the
• TREND ?

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RATIO ANALYSIS

• 1. Capital Adequacy
• 2. Asset Quality
• 3. Management
• 4. Earnings Efficiency
• 5. Liquidity

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RATIO ANALISISCAPITAL ADEQUACY

• The Capital of a Bank protects the Bank against
  unexpected future losses.

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RATIO ANALYSISCAPITAL ADEQUACY

• 1.
• Shareholders Equity
  ------------------------------------
• Total Assets
• The ability of the present Capital to support
  the further growth of Assets

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RATIO ANALYSISCAPITAL ADEQUACY

• 2.
• Shareholders Equity
  ------------------------------------
• Risk Weighted Assets

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RATIO ANALYSISCAPITAL ADEQUACY

• 3.
• Shareholders Equity
  ------------------------------------
• Risk Weighted Assets
  RW Contingent Liabilities

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RATIO ANALYSISCAPITAL ADEQUACY

• 4.
• Total Debt
  ------------------------------------
• Shareholders Equity
• The ability to raise additional Debt Capital

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RATIO ANALYSISCAPITAL ADEQUACY

• 5. Financial Leverage
• Total Assets
  ------------------------------------
• Shareholders Equity

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RATIO ANALYSISCAPITAL ADEQUACY

• 6. Capital Formation Rate
• Retained Net Income (RNI)
  
  ---------------------------------------
  -----------
• Average Shareholders Equity
• RNI Net Income - Dividends to be paid
• The internal growth of Equity Capital

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RATIO ANALISISASSET QUALITY

• 1.
• Loans
  --------------------------------
• Total Assets

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RATIO ANALISISASSET QUALITY

• 2. Non Performing Loans
• a) Loans past due more than 90 days
• b) Loans not accruing interest
• c) Loans with low interest rates
• d) Loans on which repayment terms
  have been renegotiated.

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RATIO ANALISISASSET QUALITY

• 3. Non Performing Loans
  -------------------------------------
• Total Loans
• Indicates how much of the loan portfolio is non
  performing.

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RATIO ANALISISASSET QUALITY

• 4. Reserves for Non Performing Loans
  ----------------------------------------------
• Non Performing Loans
• Indicates the ability of the loan loss reserve to
  absorb potential losses from currently non
  performing loans.

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RATIO ANALISISASSET QUALITY

• 5. Loan Loss Provision
  -------------------------------------
• Average Loans
• Shows current income reduction in anticipation of
  loan losses.

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RATIO ANALISISASSET QUALITY

• 6. Net Charge - Offs
  -------------------------------------
• Average Loans
• Shows current income reduction in anticipation of
  loan losses.

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RATIO ANALISISASSET QUALITY

• 7.
• Interest Earning Assets
  -------------------------------------------------
• Total Assets

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RATIO ANALISISASSET QUALITY

• 8.
• Non Interest Earning Assets
  -------------------------------------------------
• Total Assets

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RATIO ANALISISEARNINGS EFFICIENCY

• A Bank with no profit is like a human body with
  no blood.

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THE PRIMACY OF EARNINGS

• A bank can not sustain itself long without a
  positive cash flow.
• Earnings are essential to
• 1.Absorb loan losses
• 2.Finance internal growth of capital
• 3.Attract investors to supply capital

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RATIO ANALISISEARNINGS EFFICIENCY

• 1. Return on Assets ( ROA )
• Net Income
  --------------------------------------------
• Total Average Assets

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RATIO ANALISISEARNINGS EFFICIENCY

• 2. Return on Equity ( ROE )
• Net Income
  --------------------------------------------
• Average Shareholders Equity

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RATIO ANALISISEARNINGS EFFICIENCY

• 3. Return on Equity ( ROE )
• ROE ROA Equity Multiplier
• ROE ( NI / AST ) ( AST / SHEQ )

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RATIO ANALISISEARNINGS EFFICIENCY

• 4.
• Interest Income
  --------------------------------------------
• Average Interest Earning Assets

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RATIO ANALISISEARNINGS EFFICIENCY

• 5.
• Net Interest Income
  --------------------------------------------
• Average Total Assets

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RATIO ANALISISEARNINGS EFFICIENCY

• 6.
• Interest Income on Loans
  --------------------------------------------
• Average Total Loans

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RATIO ANALISISEARNINGS EFFICIENCY

• 7.
• Total Operating Expense
  -------------------------------------------
  ------
• Total Operating Income

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RATIO ANALISISEARNINGS EFFICIENCY

• 8. Efficiency Ratio
• Non Interest Expense
  -------------------------------------------------
  ---
• Net Interest Income Fees Commissions

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RATIO ANALISISEARNINGS EFFICIENCY

• 9. Break Even Ratio
• Total Expenses - Non Interest Income
  -------------------------------------------------
  ---
• Total Average Interest Earning Assets

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RATIO ANALISISEARNINGS EFFICIENCY

• 10. Net Free Funds Ratio
• Non Paying Liabilities - Non Earning
  Assets
  -------------------------------------------------
  -
• Interest Earning Assets

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RATIO ANALISISEARNINGS EFFICIENCY

• 11. Interest Rate Sensitivity Gap
• Interest Rate Sensitive Assets
  ( minus )
• Interest Rate Sensitive Liabilities
• Shows the net amount to be effected by the future
  change of interest rates in the market

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RATIO ANALISISEARNINGS EFFICIENCY

• 12. Interest Rate Sensitivity Gap Ratio
• Interest Rate Sensitive Assets
  -------------------------------------------------
• Interest Rate Sensitive Liabilities

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RATIO ANALYSISLIQUIDITY

• Inadequate Liquidity of a Bank may cause an
  accident similar to an airplane crash !

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RATIO ANALISISLIQUIDITY

• 1.
• Loans
  -------------------------
• Deposits

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RATIO ANALISISLIQUIDITY

• 2.
• Liquid Assets
  -------------------------
• Deposits

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RATIO ANALISISLIQUIDITY

• 3.
• Liquid Assets
  --------------------------------
• Deposits Borrowings

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RATIO ANALISISLIQUIDITY

• 4.
• Assets Due for the Period
  -----------------------------------------
• Liabilities Due for the Period

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RATIO ANALISISLIQUIDITY

• 5. Net Large Liabilities
  -----------------------------------------
• Net Earning Assets
• Both numerator denominator are net of
  short-term assets.
• Measures the extent to which net earning assets
  would be effected by the loss of a banks large
  liabilities.

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RATIO ANALISISLIQUIDITY

• 6. Liquid Assets
  -----------------------------------------
• Large Liabilities
• Measures the assets readily available to cover a
  loss of large liabilities.

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RATIO ANALISISLIQUIDITY

• 7. Core Deposits
  -----------------------------------------
• Earning Assets
• Indicates the extend to which earning assets are
  funded by those deposits considered stable and
  not subject to interest rate disintermediation.

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RATIO ANALISISLIQUIDITY

• 8. Brokered Deposits
  -----------------------------------------
• Earning Assets
• Measures the extent to which a bank is funding
  assets with high-priced and volatile brokered
  deposits.

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MATURITY ANALISIS
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MATURITY ANALYSIS
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OFF - BALANCE SHEET RISK

• 1. Loan Commitments
  -----------------------------------------
• Average Assets
• Shows the extent of a banks obligation to make
  loans.

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OFF - BALANCE SHEET RISK

• 2.Contingent Liabilities Commitments
  --------------------------------------------------
  --
• Average Assets
• Shows the extent of a banks commitments
  contingent liabilities.

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BANK ANALYSIS

• CHECKLIST

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BANK ANALYSIS CHECKLIST

• EARNINGS
• 1. Is earnings at an adequate level ?
• 2.Does valid reporting exist for earnings?

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BA CHECKLIST EARNINGS

• IF POOR, ASCRIBABLE TO
• 1. Low asset yield
• 2. High cost of funds
• 3. Inadequate non interest income
• 4. High loan charge off s
• 5. High loan loss provisions
• 6. Mismanaging taxes
• 7. High overhead costs

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BA CHECKLIST EARNINGS

• IF STRONG, ASCRIBABLE TO
• 1. Strong asset yield
• 2. Low cost of funds
• 3. Adequate non - interest income
• 4. High loan charge off s
• 5. High loan loss provisions
• 6. Adequate taxes
• 7. Low overhead costs

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BANK ANALYSIS CHECKLIST

• CAPITAL ADEQUACY
• 1. Is level of capital high enough ?
• 2. Is capital growing proportionate to assets
  ?
• 3. Can additional debt be raised if needed
• 4. Is there pressure to pay high dividends

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BANK ANALYSIS CHECKLIST

• LIQUIDITY
• 1. Is bank dependent on bought money ?
• 2. Is this dependence traditional or recent
• 3. Is core deposit growth proportionate to
  asset growth ?
• 4. Is volatile funds significant to assets

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BANK ANALYSIS CHECKLIST

• ASSET QUALITY
• 1. Are net charge - off s reasonable ?
• 2. Is management slow to charge off loans
• 3. Is loan growth reasonable ?
• 4. Is loan loss reserve level adequate ?
• 5. Do earnings comfortably cover loan losses
  ?

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INTEREST MARGIN

• INCREASING THE
• INTEREST MARGIN

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INCREASING INTEREST MARGIN

• Interest Income..200
• Interest Expense( 50 )
  ----------
• INTEREST MARGIN.. 150
  ----------

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INCREASING THE INTEREST MARGIN
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INCREASING THEINTEREST MARGIN

• BANK STRATEGY
• Increase Size

• ACTION
• 1.Expand Assets
• 2.Reduce Fixed Assets
• 3.Increase Equity Base

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INCREASE THEINTEREST MARGIN

• BANK STRATEGY
• ChangeInterest Spread

• ACTION
• 1.Re-Price Asset Portfolio
• 2.Re-Price Liability Portfolio

100
INCREASE THEINTEREST MARGIN

• ACTION
• 1.Plan Taxes
• 2.Reduce Liquidity
• 3.Increase Aggressiveness
• 4.Change Asset Yield Sensitivity
• 5.Change Liability Cost Sensitivity

• BANK STRATEGY
• AlterAsset / LiabilityMix

101
INCREASE THEINTEREST MARGIN

• IMPLEMENTATION
• 1.Offer new Products and Services
• 2.New Loans/Deposits
• 2.Open new Branches
• 3.Expand Promotion Budget
• 4.Reduce Interest Spread

• BANK STRATEGYIncrease Size
• ACTIONExpand Assets

102
EXPAND ASSETS

• IMPLEMENTATION
• 1.Offer new Products and Services
• 2.New Loans/Deposits
• 3.Open new Branches
• 4.Expand Promotion Budget
• 5.Reduce Interest Spread

• REPERCUSSION
• 1.Increase operating Expenses
• 2.Need for Capital
• 3.F/A Regulations
• 4.Decrease Capital Ratio
• 5.Reduce ROA

103
INCREASE THEINTEREST MARGIN

• BANK STRATEGYIncrease Size
• ACTIONIncreaseEquity Base

• IMPLEMENTATION
• 1.Reduce Dividend pay out
• 2.Offer Dividend reinvestment
• 3.Sell Stock
• 4.Establish Employee Stock Ownership PL

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INCREASE EQUITY BASE

• REPERCUSSIONS
• 1.Hurt shareholders
• 2.Double taxation S/H3.Reduce ability to
  leverage ROA, dilution of earnings
• 4.Continued Employee Expectations

• IMPLEMENTATION
• 1.Reduce Dividend pay out
• 2.Offer Dividend reinvestment
• 3.Sell Stock
• 4.Establish Employee Stock Ownership PL

105
INCREASE INTEREST MARGIN

• BANK STRATEGYChange Interest Spread
• ACTIONRe-price Portfolio

• IMPLEMENTATION
• 1.Increase rates on Loans
• 2.Compound return more frequently
• 3.Reduce rates on Deposits
• 4.Compound cost less frequently

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REPRICE PORTFOLIO

• REPERCUSSIONS
• 1.Lose business Loan quality decrease
• 2.Increase operations Client dissatisfaction
• 3.Lose business Liquidity problem
• 4.Increase operations Client dissatisfaction

• IMPLEMENTATION
• 1.Increase rates on Loans
• 2.Compound return more frequently
• 3.Reduce rates on Deposits
• 4.Compound cost less frequently

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INCREASE INTEREST MARGIN

• BANK STRATEGY
• Alter Asset/Liability Mix
• ACTION
• Reduce Liquidity

• IMPLEMENTATION
• 1.Minimize cash
• 2.Minimize due from
• 3.Sell Securities Bonds
• 4.Increase short term Deposits

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REDUCE LIQUIDITY

• REPERCUSSION
• 1.Liquidity Risk
• 2.Lose correspondent
• 3.Incur book losses
• 4.Increase volatility of deposits

• IMPLEMENTATION
• 1.Minimize cash
• 2.Minimize due from
• 3.Sell Securities Bonds
• 4.Increase short term Deposits

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INCREASE INTEREST MARGIN

• BANK STRATEGY
• Alter Asset/Liability Mix
• ACTION
• Increase Aggressiveness

• IMPLEMENTATION
• 1.Increase loan/deposit ratio
• 2.Increase highest yielding loans
• 3.Increase highest yielding securities

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INCREASE AGGRESSIVENESS

• REPERCUSSION
• 1.Increase need for capital
• 2.Increase loan losses
• 3.Increase security losses

• IMPLEMENTATION
• 1.Increase loan/deposit ratio
• 2.Increase highest yielding loans
• 3.Increase highest yielding securities

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INCREASE INTEREST MARGIN

• BANK STRATEGY
• Alter Asset/Liability Mix
• ACTION
• Change Asset Yield Sensitivity

• IMPLEMENTATION
• 1.Increase S/T variable rate assets if rates
  will increase
• 2.Decrease S/T variable rate assets if rates
  will decrease

112
CHANGE ASSET YIELD SENSITIVITY

• REPERCUSSION
• 1.Wrong estimate of interest movement, thereby
  reducing interest spread

• IMPLEMENTATION
• 1.Increase S/T variable rate assets if rates
  will increase
• 2.Decrease S/T variable rate assets if rates
  will decrease

113
INCREASE INTEREST MARGIN

• BANK STRATEGY
• Alter Asset/Liability Mix
• ACTION
• Change Liability Cost Sensitivity

• IMPLEMENTATION
• 1.Decrease S/T variable rate liabilities if
  rates will increase
• 2.Increase S/T variable rate liabilities if
  rates will decrease

114
CHANGE LIABILITY COST SENSITIVITY

• REPERCUSSION
• 1.Wrong estimate of interest movement, thereby
  reducing interest spread

• IMPLEMENTATION
• 1.Decrease S/T variable rate liabilities if
  rates will increase
• 2.Increase S/T variable rate liabilities if
  rates will decrease

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CONSOLIDATED

• FINANCIAL STATEMENTS

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CONSOLIDATED BALANCE SHEET