Chap 3- Financial Statement and Performance Financial Ratios

Flashcards for reviewing key concepts about commercial banks' financial statements and performance financial ratios.

Financial statements include

Balance sheet

Income statement

Cashflow statement

Notes to the financial statement

Balance Sheet

A financial statement of the wealth of a business or other organization on a given date, usually at the end of the financial year. For commercial banks, it lists all the book values of sources and uses of banks’ funds.

Banks’ uses of funds

Cash,

Liquid assets (securities),

Short-term money market instruments,

Bank loans,

Other investments,

Fixed assets (branch network, computers, premises).

Banks’ sources of funds

The general public (retail deposits),

Companies (small, medium, and large corporate deposits),

Other banks (interbank deposits),

Equity issues (share issues, conferring ownership rights on holders),

Debt issues (bond issues and loans),

Saving past profits (retained earnings).

Main purpose of having Cash and deposits with other depository institutions

Liquidity

Sub-items of Cash and deposits with other depository institutions

Cash and cash equivalents,

Deposits at the central bank,

Deposits and loans to other credit institutions

Main purpose of Securities

Profitability and Add-on liquidity

Sub-items of Securities

Available-for-sale securities and

Held-to-maturity securities

Main purpose of Bank loans

Profitability

Ingredient of Bank Loans

Loans to other credit institutions,

Retail loans,

Corporate loans

Other asset items

• Capital contribution, long term investment

• fixed asset

• receivable, interest, fees..

Deposits from customers

Liabilities

Current deposit account

Time (saving) deposit

Equity

Charter capital,

Surplus premium,

Reserves,

Retained profits

Off Balance Sheet Items of Banks

Credit guarantees,

Foreign exchange commitments,

L/C,

Loan sales,

Other commitments

Interest Income

The income generated on all banks’ assets, such as loans, securities and deposits lent out to other institutions, households and other borrowers; main source of bank revenue, sensitive to interest rate, and subject to credit risk.

Interest Expense

The sum of interest paid on all interest-bearing liabilities, such as all deposit accounts, CDs, short-term borrowing and long-term debt; biggest expense of the bank and dependent of market interest rates, customer psychology, economic cycle, legal corridor.

Non-interest Income

The income generated by fee income, deposit service charges, commissions (Bancasurance) and trading (loss)/gain; accounts for a relatively low proportion but has become important in recent years, low risk, and less dependent on market interest rate fluctuations.

Non-interest Expenses

Salaries and fringe benefits paid to employees, property and equipment expenses, and other non-interest expenses (such as deposit insurance premiums and depreciation); a relatively low share of the total cost and less dependent on market interest rate fluctuations.

Allowance for credit losses

A non-cash expense item, which the amount charged against earnings to establish a reserve sufficient to absorb expected loan losses.

The importance of evaluate financial statements and performance ratios

• For banks

More intense competition, greater pressure for banks to control costs and manage risk while maximize revenue

Need to evaluate to make decisions

• For stakeholders

Performing analysis is an important tool used by various of agents (both external and internal)

ROA (Return-on-asset)

Net income/total assets

Indicates how much net income is generated per $ of assets.

ROE (Return-on-equity)

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Net income/total equity

the rate of return to shareholders/ the percentage return on each $ of equity invested in the bank.

ROE high → using equity effective

NIM (Net income margin)

[(interest income – interest expense)/total assets]

measures the net interest income relative to the bank’s total, average or earning assets.

NIM high → good monitoring

C/I (Cost- income ratio)

Non-interest expenses/(interest income + non–interest income);

a quick test of efficiency that reflects bank non-interest costs as a proportion of income

CI low → effective (income can cover expense with an amount of profit)

CAR (Capital Adequacy ratio)

=(Tier 1 Capital + Tier 2 Capital) / Risk Weighted Assets

requires banks to hold a minimum overall risk-weighted capital ratio of 8%

• Tier 1: equity (at least 4% - 50%)

• Tier 2: general provision (long term debt instrument)

• Risk weighted asset (high risk loans)

Limitation of finacial ratios

• One year’s figure are insufficient to evaluate the performance

• Precise comparisons between banks is diff

• Ratios do not stand in isolation, they are interrelated