banking statement analysis

7/28/2019 Banking Statement Analysis

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FINANCIAL MANAGEMENT

OF BANKS

Macro Aspects of Banking


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Understanding Banks

Financial Statement


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Balance Sheet

Sources of Funds (Bank Liabilities)1. Net Worth

(a) Capital

(b) Reserve & Surplus = Statutory Reserve +

Capital Reserves + Share Premium + Revenue

and other Reserves + Balance in P&L Account

2. Deposits

(a) Demand Deposits

(b) Saving Deposits

Term Deposits


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1. Borrowings2. Other Liabilities and Provisions

(a) Bills Payable

(b) Interest accrued

Others


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Uses of Funds (Bank Assets)

1. Cash and balances with the RBI

2. Balances with banks and money at call and short

notice

3. Investments:

Government securities Approved securities

Shares

Debentures and bonds Subsidiaries and / or joint ventures

Other investments


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4. Loans and advances:

(a) By nature of credit facility

(b)By security arrangements

By sector

5. Fixed assets:

(a) Premises (including land)

(b) Other assets (including furniture and

fixtures)

Assets on lease

6. Other assets


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Contingent Liabilities

a) claims against the bank not

acknowledged as debts

b) Liability on account of outstanding

forward exchange contracts

c) Guarantees given on behalf of outside

constituents

d) Currency swaps, interest rate swaps &

futures


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Income Statement

Sources of Income

Interest Earned

Interest / discount on advances/bills

Income from investments

Interest on balances with RBI and otherinter-bank funds

Others


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Other Income

Commission, exchange and brokerageProfit/loss on sale of investments

Profit/loss on revaluation of investments

Profit/loss on sale of building and otherassets

Profit on exchange transactions

Income earned by way of dividends

Miscellaneous income


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Sources of Expenses

Interest Expended

Interest on deposits

Interest on RBI / inter-bank borrowings

Other Interest

Operating Expenses Payments to and provisions for employees

Rent, taxes and lighting

Printing and stationery

Advertisement and publicity Depreciation on banks property

Directors fees, allowances and expenses

Auditors fees and expenses

Law charges Posta e tele hone etc.


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Provisions and Contingencies

Other Disclosures to be made by Banks in

India = The banks are mandated to discloseadditional information as part of annual financial

statements as follows:

1.Capital adequacy ratio2. Gross value of investments

3. Repo transactions

4. Non-SLR investment portfolio

5. Forward rate agreement/interest rate swap

6. Movements in NPAs


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Camels Model

Regulators, analysts and investors have to

periodically assess the financial condition of

each bank. Banks are rated on variousparameters, based on financial and non-

financial performance.

CAMELS is an acronym, where each letterrefers to a specific category of performance.


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CAMELS model objectives.

Ratings are assigned for each component in

addition to the overall rating of a banksfinancial condition. The ratings are assigned

on a scale from 1 to 5.

Rating analysis and interpretation


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CAMEL MODEL

C - Capital Adequacy

- Capital adequacy ratio

- Debt-Equity Ratio

- Advances to Assets

- G-Secs to Total Investments

A - Asset Quality

- Gross NPAs to Net Advances

- Net NPAs to Net Advances

- Total Investments to Total Assets- Percentage change in Net NPAs

- Net NPAs to Total Assets


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M- Management

- Profit per Branch

- Total Advances to Total Deposits- Business per Employee

- Profit per Employee

E- Earning Quality- Operating Profits to Average Working Funds

- Percentage Growth in Net Profits

- Spread

- Net Profit to Average Assets

- Interest Income to Total Income

- Non-Interest Income to Total Income


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L- Liquidity- Liquid Assets to Total Assets

- G-Secs to Total Assets

- Liquid Assets to Demand Deposits- Liquid Assets to Total Deposits

SSensitivity to market risk


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Pricing Deposit Services Need to price deposit services = The pricing

of deposits and related services assumes greatimportance in the present deregulated and highlycompetitive environment, where deposit rate ceiling donot exist. However, banks have to monitor the cost oftheir funding sources carefully for the following reasons:

1. Changes in cost of funds would require changes in assetyields to maintain spreads.

2. Changes in cost of funds could alter the liability mix ofbanks and expose the bank to liquidity constraints.

3. Changes in cost of funds could render the bank lesscompetitive in the market.

It is, therefore, imperative that banks understand how tomeasure the cost of their funding sources andaccordingly price their assets in order to ensure a desired

level of profitability. This is done through a pricing


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Approaches to deposit pricing

Market penetration deposit pricing

Conditional pricing

Upscale target pricing

Deposits and interest rate risk


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Management of Credit Risk

Loans


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Introduction

Expected versus Unexpected loss

Defining credit risk

the risk in individual credits ortransactions.

the credit risk inherent in the entire

portfolio. the relationships between credit risk and

other risks.


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BASEL Committees Principles

of Credit Risk ManagementThe committee focuses on the following areas:

1. Establishing an appropriate credit risk environment;

2. Operating under a sound credit granting process;

3. Maintaining an appropriate credit administration,

measurement and monitoring process; and4. Ensuring adequate controls over credit risk.


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Credit Risk Models

Lenders try to diversify their credit risks, forthey know that they cannot do business if

they eliminate risks altogether. How canlenders diversify their risk? By avoidingconcentration of credit.

Basic model

A simple method of estimating credit risk is toassess the impact of NPA write-offs on the banks

profit.


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PBT/NPA. Here PBT is more relevant since losses

written off typically enjoy tax shields.

(PBT/TA) / (NPA/TA)Interpretation

Credit scoring model


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Credit Risk TransfersLOAN SALES

Syndication

Novation

Securitisation

The securities sold to investors are called ABS,since they are backed by the homogeneous pool of

underlying assets. Originators of ABS usually

want to sell loans without recourse. Hence

investors usually safeguard their interests through

three mechanisms(a) overcollateralisation, (b)

senior/subordinated structures, credit

enhancement.


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CREDIT DERIVATIVES

CD are an effective means of protecting against

credit risk. They come in many shapes and sizes,but all serve the same purpose. Simply stated, a

credit derivative is a security with a pay-off

linked to a credit related event, such as borrower

default, credit rating downgrades. Some basic credit derivative structures:

1. Loan portfolio swap

2. Total return swap3. Credit default swap (CDS)

4. Credit risk options


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5. Credit linked notes

6. Credit linked deposits / credit linked

certificates of deposit

7. Basket default swap


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Treatment of Credit Risk in India

Credit and investment exposure

What are non-performing assets

Prudential norms for income recognition

Prudential norms for asset classification

Provisioning norms


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Management of Interest rate and

Liquidity Risk

AssetLiability Management


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Introduction 90% of Bank As liabilities mature within the next 12

months. Bank A has invested 80% of these funds insecurities maturing after 5 years.

90% of Bank Bs liabilities mature within the next 12months. Bank B lends 75% of these funds to variousinfrastructure projects, where the repayment will start after

an initial payment holiday of 2 years.

80% of Bank Cs liabilities mature after 3 years and havebeen borrowed at a fixed cost. Interest rates are on adownward trend, and 80% of Bank Cs loan portfolio

consists of short-term loans to be fully repaid over the nextsix months.

Bank D has entered into dollar forward contracts at apremium for 6 months on behalf of its importer borrowers,who form about 60% of the banks loan portfolio. There is

a fall in dollar value during this period.


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Concept & Objective of ALM The maturity mismatches and disproportionate

changes in the level of assets and liabilities cancause both liquidity and interest rate risk.

ALM is an integrated strategic managerialapproach of managing of total balance sheetdynamics having regard to its size and quality insuch a way that the net earnings from interest in

particular are maximized with the overall riskpreference of the institution.

The focus is not on building up of deposits andloans/assets in isolation but on net interest incomeand recognizing interest rate and liquidity risks.This is essentially a guide for survival in a

deregulated environment.


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Objective:1. To control the volatility of net interest

income and net economic value of a bank.

2. To control liquidity risk.

3. To control volatility in target accounts,

and

4. To ensure an acceptable balance between

profitability and growth rate.


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Measuring Interest Rate Risk Banks use various techniques to measure the

exposure of earnings and economic value tochanges in interest rates.

Before we examine the various approaches, wewill have to understand what determines interest

rate sensitivity. Typically, a banks asset orliability is classified as rate sensitive within aspecified time interval if

It matures during the time interval;

The interest rate applied to the outstanding advance changescontractually during the interval;

It represents an interim or partial principal payment;

The outstanding principal can be repriced when some base rate orindex changes; and there is an expectation that the base rate or indexmay change during the interval.


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Methods to measure interest rate risk

1. Traditional GAP analysis

2. Earnings sensitivity analysis (Earnings at risk)3. Rate adjusted gap

4. Duration GAP analysis

Managing interest rate riskIRD1. Swaps

2. Interest rate futures

3. Forward rate agreements4. Interest rate options

5. Interest rate guarantees

6. Swaptions


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Liquidity Risk Management

Sources of liquidity risk

1. Access to financial markets

2. Financial health of the bank

3. Balance sheet structure

4. Liability and asset mix

5. Timing of fund flow

6. Exposures to off-balance sheet activity


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Approach to managing liquidity in long-term

1. Asset management

2. Liability management

Approach to managing liquidity in the short-

term

1. Projected sources and uses of funds over the planning

horizon2. Working funds approach

3. Cash flow or funding gap report

4. Funds availability report

5. Ratio analysis

6. Historical funds flow analysis


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Capital Risk

Regulation and Adequacy


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Prudential Regulation

Economic regulation and prudential regulation Prudential regulatory model calls for imposing the

regulatory capital level to maintain the health of

banks and the soundness of the financial system.

The Reserve bank of India issued prudentialnorms based on the recommendations of the

Narsimham Committee report. These norms strive

to ensure that banks conduct their business

activities as prudent entities, that is, not indulging

in excessive risk taking and violating regulations

in pursuit of profit.


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BASEL Committee

What is BASEL committee?

BASEL Capital Accord 1988: The Basle CapitalAccord of 1988 refers to the agreement amongmember countries of the Basle Committee onBanking Supervision on a method of ensuring a

banks capital adequacy.

The Basel norm of capital adequacy wasintroduced in India following therecommendations of the Narsimham Committee(1991).


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Capital Adequacy

Capital adequacy ratio is a measure of theamount of a banks capital expressed as a

percentage of its risk-weighted assets.

This capital framework, based on theBasel committee proposals, prescribes two

tiers of capital for the banks:

1. Tire-I capital which can absorb losses without a bank

being required to cease trading and

2. Tier-II capital which can absorb losses in the event of a

winding-up.


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Tier-II capital should not be more than 100

percent of Tier-I capital and subordinateddebt instruments should be limited to 50

percent of Tier-I capital. Revaluation

reserve should be applied a discount of 55%for inclusion in Tier-II capital. General

provisions/loss reserves should not exceed

1.25 percent of the total weighted risk

assets.

Risk weight of assets.

banking statement analysis

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