Analysis of The Balance Sheets of Commercial Banks

ANALYSIS OF THE
BALANCE SHEETS OF
COMMERCIAL BANKS
AD-477 BANK MANAGEMENT

Instructor……Bülent Şenver
BS Trainig Services 1
BALANCE SHEET
ANALYSIS
• OF
• COMMERCIAL
BANKS
ANNUAL REPORT
OF
BANKS
ANNUAL REPORT
• 1. AUDITOR’S
REPORT (AR)
• 2. FINANCIAL
STATEMENTS (F/S)
• 3. NOTES TO F/S
AUDITOR’S
REPORT
“INDEPENDENT
AUDITOR’S REPORT”
INDEPENDENT AUDITORS’
REPORT
• 1.What is done ?
• 2.What is audited ?
• 3.What is the auditor’s & management’s
responsibility ?
• 4.Audit is done based on what standard ?
• 5.Auditors’ opinion based on IAS
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
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.
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.
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
FINANCIAL
STATEMENTS
OF
COMMERCIAL BANKS
FINANCIAL STATEMENTS
• 1. BALANCE SHEET
• 2. STATEMENT OF INCOME
• 3. STATEMENT OF
SHAREHOLDER’S EQUITY
• 4. SOURCES & USES OF FUNDS
STATEMENT
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
BALANCE SHEET
SHOWS
• The Financial Position • As at a specific date.

of a Bank
• As of Dec. 31,1998
BALANCE SHEET
EQUATION
• 100 = • = 100
• ASSETS = • LIABILITIES
• Equals • + Plus
• SHAREHOLDER’S
EQUITY
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
BALANCE SHEET Liabilities
• Deposits 400
• Bank Borrowings 150
• Accrued Expenses 100
• Other Liabilities 80
• Bonds Issued 70
• Shareholder’s Equity 250
• Total Liabilities & S/HE 1050
SHAREHOLDER’S EQUITY
• Share Capital 100
• Legal Reserves 30
• Retained Earnings 50
• Revaluation Surplus 20
• Share Premiums 10
• Net Income 40
• Total S/H Equity 250
ASSET VALUATION
• GAAP & IAAP
• Generally Accepted & • LOWER OF

Internationally • COST OR
Accepted Accounting • MARKET
Principles
ASSET CLASSIFICATION
TO TAL
ASSETS
N O N IN T E R E S T E A R N IN G IN T E R E S T E A R N IN G
ASSETS ASSETS
LIABILITY
CLASSIFICATION
TO TAL
L IA B IL IT IE S
IN T E R E S T B E A R IN G N O N IN T E R E S T B E A R IN G
L IA B IL IT IE S L IA B IL IT IE S
BALANCE SHEET
DOES NOT SHOW
• Interest Rates
• Interest Sensitivity
• Due Dates
• Foreign Currency
breakdown
• Collateral
STATEMENT OF INCOME
SHOWS
• The results of • For the period

operations of a bank. between two dates.
• For the year ended

Dec. 31 , 1998
NET PROFIT
N E T P R O F IT
TO TAL TO TAL
IN C O M E EXPEN SE
TOTAL INCOME
TO TAL
IN C O M E
N ET N ET
IN T E R E S T N O N - IN T E R E S T
IN C O M E IN C O M E
NET INTEREST INCOME
N ET
IN T E R E S T
IN C O M E
IN T E R E S T IN T E R E S T
IN C O M E EXPEN SE
(+ ) (-)
NET INTEREST INCOME
N ET
IN T E R E S T
IN C O M E
IN C O M E EXPEN SE
P /L P /L
E A R N IN G B E A R IN G
ASSETS L IA B IL IT IE S
B /S B /S
NET NON-INTEREST
INCOME
N ET
N O N - IN T E R E S T
IN C O M E
N O N N O N
IN C O M E EXPEN C E
(+ ) (-)
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
ANALYSIS OF PROFIT
NET
P R O F IT
(N P )
P R O F IT F R O M P R O F IT F R O M P R O F IT F R O M
B A N K IN G O P E R A T IO N S E X T R A O R D IN A R Y S E C U R IT Y
( N E T O P E R A T IN G IN C O M E ) T R A N S A C T IO N S T R A N N S A C T IO N S
( N O I) (P E X T ) (P S T )
BANKING
RISKS
BANKING RISKS
•C AMEL
• A
• M
• E
• L
CAMEL
• Capital
Adequacy
C AMEL
• Asset
Quality
CA MEL
• Management
Quality
CAM EL
• Earnings
Efficiency
CAME L
• Liquidity
Risk
CAMEL RISKS
• Capital
Adequacy
• Asset Quality
• Management
• Earnings
• Liquidity
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
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
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
RATIO ANALYSIS
Numerator
______________________
Denominator
RATIO ANALYSIS
• Balance Sheet • Income Statement

__________________ ________________
Balance Sheet Balance Sheet
RATIO ANALYSIS
• What is the • What is the
• LEVEL ? • TREND ?
RATIO ANALYSIS
• 1. Capital Adequacy
• 2. Asset Quality
• 3. Management
• 4. Earnings & Efficiency
• 5. Liquidity
RATIO ANALISIS
CAPITAL ADEQUACY
• “The Capital of a
Bank protects the
Bank against
unexpected future
losses.”
RATIO ANALYSIS
CAPITAL ADEQUACY
• 1.
• Shareholders’ Equity
------------------------------------
• Total Assets
• The ability of the present Capital to support

the further growth of Assets
RATIO ANALYSIS
CAPITAL ADEQUACY
• 2.
------------------------------------
• Risk Weighted Assets
RATIO ANALYSIS
CAPITAL ADEQUACY
• 3.
------------------------------------
• Risk Weighted Assets
+
RW Contingent Liabilities
RATIO ANALYSIS
CAPITAL ADEQUACY
• 4.
• Total Debt
------------------------------------
• Shareholder’s Equity
• The ability to raise additional Debt Capital

RATIO ANALYSIS
CAPITAL ADEQUACY
• 5. Financial Leverage :
• Total Assets
------------------------------------
• Shareholder’s Equity
RATIO ANALYSIS
CAPITAL ADEQUACY
• 6. Capital Formation Rate :
• Retained Net Income (RNI)
--------------------------------------------------
• Average Shareholder’s Equity
• RNI = Net Income - Dividends to be paid
• The internal growth of Equity Capital
RATIO ANALISIS
ASSET QUALITY
• 1.
• Loans
--------------------------------
• Total Assets
RATIO ANALISIS
ASSET 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.
•
RATIO ANALISIS
ASSET QUALITY
• 3. Non Performing Loans
-------------------------------------
• Total Loans
• Indicates how much of the loan portfolio is

non performing.
RATIO ANALISIS
ASSET 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.
RATIO ANALISIS
ASSET QUALITY
• 5. Loan Loss Provision
-------------------------------------
• Average Loans
• Shows current income reduction in

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

anticipation of loan losses.
RATIO ANALISIS
ASSET QUALITY
• 7.
• Interest Earning Assets
-------------------------------------------------
• Total Assets
RATIO ANALISIS
ASSET QUALITY
• 8.
• Non Interest Earning Assets
-------------------------------------------------
• Total Assets
RATIO ANALISIS
EARNINGS & EFFICIENCY
• “A Bank with no
profit is like a human
body with no blood.”
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
RATIO ANALISIS
• 1. Return on Assets ( ROA )
• Net Income
--------------------------------------------
• Total Average Assets
RATIO ANALISIS
• 2. Return on Equity ( ROE )
• Net Income
--------------------------------------------
• Average Shareholder’s Equity
RATIO ANALISIS
• 3. Return on Equity ( ROE )
• ROE = ROA * Equity Multiplier
• ROE = ( NI / AST ) * ( AST / SHEQ )
RATIO ANALISIS
• 4.
• Interest Income
--------------------------------------------
• Average Interest Earning Assets
RATIO ANALISIS
• 5.
• Net Interest Income

--------------------------------------------
• Average Total Assets
RATIO ANALISIS
• 6.
• Interest Income on Loans

--------------------------------------------
• Average Total Loans
RATIO ANALISIS
• 7.
• Total Operating Expense

-------------------------------------------------
• Total Operating Income
RATIO ANALISIS
• 8. Efficiency Ratio
• Non Interest Expense

----------------------------------------------------
• Net Interest Income + Fees Commissions
RATIO ANALISIS
• 9. Break Even Ratio
• Total Expenses - Non Interest Income

----------------------------------------------------
• Total Average Interest Earning Assets
RATIO ANALISIS
• 10. Net Free Funds Ratio
• Non Paying Liabilities - Non Earning

Assets
--------------------------------------------------
• Interest Earning Assets
RATIO ANALISIS
• 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
RATIO ANALISIS
• 12. Interest Rate Sensitivity Gap Ratio :
• Interest Rate Sensitive Assets

-------------------------------------------------
• Interest Rate Sensitive Liabilities
RATIO ANALYSIS
LIQUIDITY
• “Inadequate
Liquidity of a Bank
may cause an
accident similar to an
airplane crash !”
RATIO ANALISIS
LIQUIDITY
• 1.
• Loans
-------------------------
• Deposits
RATIO ANALISIS
LIQUIDITY
• 2.
• Liquid Assets
-------------------------
• Deposits
RATIO ANALISIS
LIQUIDITY
• 3.
• Liquid Assets
--------------------------------
• Deposits + Borrowings
RATIO ANALISIS
LIQUIDITY
• 4.
• Assets Due for the Period

-----------------------------------------
• Liabilities Due for the Period
RATIO ANALISIS
LIQUIDITY
• 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
bank’s large liabilities.
RATIO ANALISIS
LIQUIDITY
• 6. Liquid Assets
-----------------------------------------
• Large Liabilities
• Measures the assets readily available to

cover a loss of large liabilities.
RATIO ANALISIS
LIQUIDITY
• 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.
RATIO ANALISIS
LIQUIDITY
• 8. Brokered Deposits
-----------------------------------------
• Earning Assets
• Measures the extent to which a bank is

funding assets with high-priced and volatile
brokered deposits.
MATURITY ANALISIS
Days 0-10 10-30 30-60 60-90
Cash 100 200 300 50
Loans 200 500 200 100
300 700 500 150
Deposit 400 300 800 20
Borrow 150 200 200 30
550 500 1000 50
MATURITY ANALYSIS
Days 0-10 10-30 30-60 60-90
Asset 100 500 1000 2000

Liab 300 200 1500 700
Short - -200 -500

Long + +300 1300
OFF - BALANCE SHEET
RISK
• 1. Loan Commitments
-----------------------------------------
• Average Assets
• Shows the extent of a bank’s obligation to

make loans.
OFF - BALANCE SHEET
RISK
• 2.Contingent Liabilities & Commitments

----------------------------------------------------
• Average Assets
• Shows the extent of a bank’s commitments

& contingent liabilities.
BANK ANALYSIS
CHECKLIST
BANK ANALYSIS
CHECKLIST
• EARNINGS
• 1. Is earnings at an adequate level ?
• 2.Does valid reporting exist for earnings?
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
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
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
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
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 ?
INTEREST MARGIN
INCREASING THE
INTEREST MARGIN
%
INCREASING INTEREST
MARGIN
• Interest Income…………..200
• Interest Expense…………( 50 )
----------
• INTEREST MARGIN….. 150
----------
INCREASING THE
INTEREST MARGIN
BAN K STR ATEG Y TO
IN C R E A S E T H E
IN T E R E S T M A R G IN
IN C R E A S E C H AN G E ALTER
S IZ E IN T E R E S T A S S E T /L IA B IL IT Y
SPR EAD M IX
INCREASING THE
INTEREST MARGIN
• BANK STRATEGY • ACTION
• 1.Expand Assets
• 2.Reduce Fixed Assets
• Increase Size
• 3.Increase Equity Base
INCREASE THE
INTEREST MARGIN
• BANK STRATEGY • ACTION
• 1.Re-Price
Asset Portfolio
• Change
• 2.Re-Price
Interest Spread Liability Portfolio
INCREASE THE
INTEREST MARGIN
• ACTION
• BANK STRATEGY
• 1.Plan Taxes
• 2.Reduce Liquidity
• 3.Increase
• Alter Aggressiveness
Asset / Liability • 4.Change Asset Yield
Sensitivity
Mix • 5.Change Liability
Cost Sensitivity

INCREASE THE
INTEREST MARGIN
• IMPLEMENTATION
• 1.Offer new Products
• BANK STRATEGY and Services
Increase Size • 2.New Loans/Deposits
• 2.Open new Branches
• 3.Expand Promotion
• ACTION
Budget
Expand Assets
• 4.Reduce Interest
Spread

EXPAND ASSETS
• REPERCUSSION • IMPLEMENTATION
• 1.Increase operating • 1.Offer new Products
Expenses and Services
• 2.New Loans/Deposits
• 2.Need for Capital
• 3.Open new Branches
• 3.F/A Regulations
• 4.Expand Promotion
• 4.Decrease Capital Budget
Ratio
• 5.Reduce Interest
• 5.Reduce ROA Spread

INCREASE THE
INTEREST MARGIN
• IMPLEMENTATION
• BANK STRATEGY • 1.Reduce Dividend
Increase Size pay out
• 2.Offer Dividend
• ACTION reinvestment
Increase • 3.Sell Stock
Equity Base • 4.Establish Employee
Stock Ownership PL

INCREASE EQUITY BASE
• REPERCUSSIONS • IMPLEMENTATION
• 1.Hurt shareholders • 1.Reduce Dividend
pay out
• 2.Double taxation S/H • 2.Offer Dividend
3.Reduce ability to reinvestment
leverage ROA, • 3.Sell Stock
dilution of earnings
• 4.Establish Employee
• 4.Continued Employee
Stock Ownership PL
Expectations
INCREASE INTEREST
MARGIN
• IMPLEMENTATION
• BANK STRATEGY • 1.Increase rates on
Change Interest Loans
Spread • 2.Compound return
more frequently
• ACTION • 3.Reduce rates on
Re-price Portfolio Deposits
• 4.Compound cost less
frequently
REPRICE PORTFOLIO
• REPERCUSSIONS • IMPLEMENTATION
• 1.Lose business • 1.Increase rates on
Loan quality decrease Loans
• 2.Increase operations • 2.Compound return
Client dissatisfaction more frequently
• 3.Lose business • 3.Reduce rates on
Liquidity problem Deposits
• 4.Increase operations • 4.Compound cost less
Client dissatisfaction frequently
INCREASE INTEREST
MARGIN
• IMPLEMENTATION
• BANK STRATEGY
• Alter Asset/Liability • 1.Minimize cash
Mix • 2.Minimize due from
• 3.Sell Securities &
Bonds
• ACTION • 4.Increase short term
• Reduce Liquidity Deposits
REDUCE LIQUIDITY
• 1.Liquidity Risk • 1.Minimize cash

• 2.Lose correspondent • 2.Minimize due from
• 3.Incur book losses • 3.Sell Securities &
Bonds
• 4.Increase volatility of • 4.Increase short term
deposits Deposits
INCREASE INTEREST
MARGIN
• BANK STRATEGY • IMPLEMENTATION
• Alter Asset/Liability • 1.Increase loan/deposit
Mix
ratio
• 2.Increase highest
• ACTION yielding loans
• Increase • 3.Increase highest
Aggressiveness yielding securities

INCREASE
AGGRESSIVENESS
• 1.Increase need for • 1.Increase loan/deposit
capital
• 2.Increase loan losses ratio
• 2.Increase highest
• 3.Increase security yielding loans
losses • 3.Increase highest
yielding securities

INCREASE INTEREST
MARGIN
• Alter Asset/Liability • 1.Increase S/T &
Mix variable rate assets if
rates will increase
• 2.Decrease S/T &
• ACTION variable rate assets if
rates will decrease
• Change Asset Yield
Sensitivity
CHANGE ASSET YIELD
SENSITIVITY
• 1.Wrong estimate of • 1.Increase S/T &
interest movement, variable rate assets if
thereby reducing rates will increase
interest spread • 2.Decrease S/T &
variable rate assets if
rates will decrease

INCREASE INTEREST
MARGIN
• Alter Asset/Liability • 1.Decrease S/T &
Mix variable rate liabilities
if rates will increase
• 2.Increase S/T &
• ACTION variable rate liabilities
if rates will decrease
• Change Liability
Cost Sensitivity
CHANGE LIABILITY COST
SENSITIVITY
• 1.Wrong estimate of • 1.Decrease S/T &
interest movement, variable rate liabilities
thereby reducing if rates will increase
interest spread • 2.Increase S/T &
variable rate liabilities
if rates will decrease

CONSOLIDATED
FINANCIAL
STATEMENTS

CONSOLIDATED BALANCE
SHEET
PAR EN T
BAN K
C O N S O L ID A T E E Q U IT Y A C C O U N T IN G C O S T B A S IS
O w n e r s h ip O w n e r s h ip O w n e r s h ip
> 50% B tw 5 0 % - 2 0 % < 20 %
BAN K A BAN K B BAN K C

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ANALYSIS OF THE

AD-477 BANK MANAGEMENT

• We plan & perform the audit to obtain

• The Financial Position • As at a specific date.

• GAAP & IAAP

• Generally Accepted & • LOWER OF

• The results of • For the period

• For the year ended

• Interest Expense (700)

• Balance Sheet • Income Statement

• What is the • What is the

• The ability of the present Capital to support

• The ability to raise additional Debt Capital

• Retained Net Income (RNI)

• Indicates how much of the loan portfolio is

• Indicates the ability of the loan loss reserve

• Shows current income reduction in

• Shows current income reduction in

• Interest Earning Assets

• Non Interest Earning Assets

• ROE = ROA * Equity Multiplier

• ROE = ( NI / AST ) * ( AST / SHEQ )

• Net Interest Income

• Interest Income on Loans

• Total Operating Expense

• Non Interest Expense

• Total Expenses - Non Interest Income

• Non Paying Liabilities - Non Earning

• Shows the net amount to be effected by the

• Interest Rate Sensitive Assets

• Assets Due for the Period

• Measures the assets readily available to

• Indicates the extend to which earning assets

• Measures the extent to which a bank is

Asset 100 500 1000 2000

Short - -200 -500

• Shows the extent of a bank’s obligation to

• 2.Contingent Liabilities & Commitments

• Shows the extent of a bank’s commitments

• 1. Is earnings at an adequate level ?

• 2.Does valid reporting exist for earnings?

BS Trainig Services 100

BS Trainig Services 101

BS Trainig Services 102

BS Trainig Services 103

• 1.Liquidity Risk • 1.Minimize cash

BS Trainig Services 109

BS Trainig Services 110

BS Trainig Services 112

BS Trainig Services 114

BS Trainig Services 115

BAN K A BAN K B BAN K C

BS Trainig Services 116

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