How to read Banks Financial Statement

BANK BALANCE SHEET

Content of Banks Financial Statement Balance Sheet

Liabilities + Equity

Authorized Capital , Issued, Subscribed and Paid up Capital ,Debentures and Bonds ,Statutory Reserves, Other Reserves Current Deposits, Contingency Accounts , Savings Accounts , Investment Accounts (Deposits): 3 months 6 months 12 months Over 12 months , Amount due to other Banking companies , Bills payable , Other Liabilities , Contra Accounts , Profit and Loss Account (in case of profit)

Assets

Cash in hand , Balances with Central Bank , Balances with other banks and financial Institutions , Islamic securities (approved for statutory purposes) , Money at call and short notice , Investments in other Islamic securities , Financings , Bank Premises, Furniture and Equipment , Bills Receivable , Other Assets (Advance payments made, suspense account, etc.) , Contra Accounts , Profit and Loss (in case of Loss)

The usual headings appearing in the Profit and Loss account are:

Income

Profit on financings , Profit earned on inter-bank placements ,Profit on investments ,Commission, fees, exchange and brokerage ,Other income (rent, etc.) , Loss’(if expenditure exceeds income)
Expenditure
Profit paid on inter-bank funds , Salaries, allowances and other staff benefits ,Rent, taxes, insurance, lighting, etc. , Communications , Stationery and printing , Publicity and advertisement , Audit fees ,Depreciation and repairs of property , Other expenditure , Profit before tax (if income exceeds expenditure)

The Balance Sheet and Profit-and-Loss account are followed by explanatory notes on Accounts explaining material items and accounting policies followed.
Capital and Reserves
The role of Minimum capital requirement is also important in the financial Industry, although the calculation of the charge may differ, depending on the risk exposures. Basle II deals with the minimum capital requirement .This capital are the regulatory capital. The calculation of the minimum capital is derived with the help of Capital adequacy ratio (CAR), which is defined as ratio with numerator representing the amount of available capital and the denominator a measure of the risk faced by bank.
Most Central Banks require the banks to transfer a minimum percentage of their profit after tax to the Statutory Reserve till it becomes equal to the Capital amount. Other Reserves are created according to the judgment of the Board of Directors or recommendation of external Auditors, to provide against assets whose realization become doubtful.
Customer Funds
a) Current and Contingency Accounts
b) Savings
c) Investment Accounts
1. Deposits of different maturity
2. Bonds:
3. Debentures
Cash Balances
In almost every country the Central Bank requires the banks to keep a certain percentage of its liabilities in the form of cash-in-hand, and a certain percentage in the form of statutory deposits with the Central bank, which is usually interest-free. The Central banks also require a minimum percentage of the bank’s liabilities to be invested in approved financial instruments such as government securities, Treasury Bills, specified bonds, debentures and Unit Trusts.
Bank has balances with other banks and financial institutions, and money market. Money at call and short notice represents funds invested overnight or for a short period. Funds are also placed in trade pools, commodity pools.
Accounting valuation concept
Briefly, the valuation of the assets, liabilities and restricted investments of Islamic banks depends on their current cash equivalents. To make this valuation comparable and reliable, the banks should adhere to the following principles:
a) To the extent possible, realizable values in the current market should be ascertained. The market should be one in which a particular asset is normally sold or purchased by the bank.
b) All relevant information, whether positive or negative, should be utilized.
c) To the extent possible, experts in valuation should be utilized.

Risk Discloser

Disclosure of Credit Risk

With regard to credit risk, information on concentrations of financing assets by sectors/industries, geographical distribution, maturity and currency profile of the financing portfolio together with breakup of financing facilities by collectability is considered important.

However, the standard is ambiguous on the most critical information from collectability point of view, which helps the reader of financial statements to determine the extent of doubtful (non-performing) financing assets (sales receivables). The related disclosure that standard requires is that accounting policies adopted by the management for the recognition and determination of doubtful receivables and policies of writing off debts be disclosed.

Disclosure of Investment / Market Risk

The assessment of risk that arises from investments in equities or other investments (e.g., property) is as important as financing or credit risk due to the high proportion of such assets in the financial position.

Disclosure with regard to Liquidity Risk

However, there are serious concerns regarding their macro level liquidity - ability of these institutions to generate funds from other banks (including central banks) in the event of financial distress.

Disclosure of Operational Risk

Operational risk is defined as the risk of loss resulting from the inadequacy or failure of internal processes, as related to people and systems, or from external risks. Operational risk also includes the risk of failure of technology, systems, and analytical models. It is argued that operational risks are likely to be significant for Islamic banks due to their specific contractual features and the general legal environment.

Financial Analysis

Financial analysis of a company should include an examination of the financial statements of the company, including notes to the financial statements, and the auditor's report. The auditor's report will state whether the financial statements have been audited in accordance with generally accepted auditing standards. The report also indicates whether the statements fairly present the company's financial position, results of operations, and changes in financial position in accordance with generally accepted accounting principles. Notes to the financial statements are often more meaningful than the data found within the body of the statements. The notes explain the accounting policies of the company and usually provide detailed explanations of how those policies were applied along with supporting details. Analysts often compare the financial statements of one company with other companies in the same industry and with the industry in which the company operates as well as with prior year statements of the company being analyzed.

Comparative financial statements provide analysts with significant information about trends and relationships over two or more years. Financial statement ratios are additional tools for analyzing financial statements. Financial ratios establish relationships between various items appearing on financial statements. The key ratios can be classified as follows:

1 Capital Adequacy ratios: Measure for risk taking and the protection for long-term creditors and investors.

2 Liquidity ratios. Measure the ability of the enterprise to pay its debts as they mature.

3 Activity (or turnover) ratios. Measure how effectively the enterprise is using its assets.

4 Profitability ratios. Measure management's success in generating returns for those who provide capital to the enterprise.

Financial statement analysis has its limitations. Statements represent the past and do not necessarily predict the future. However, financial statement analysis can provide clues or suggest a need for further investigation. What is found on financial statements is the product of accounting conventions and procedures that can sometimes distort the economic reality or substance or the underlying situation. Financial statements say little directly about changes in markets, the business cycle, technological developments, laws and regulations, management personnel, price-level changes, and other critical analytical concerns.

Fundamental objective behind the norms is to strengthen the soundness and stability of the banking system. It is ratio of capital fund to risk weighted assets expressed in percentage terms i.e.

Minimum requirements of capital fund in India: is 8% and for Singapore it is 12%
Existing Banks 09 % ,New Private Sector Banks 10 % ,Banks undertaking Insurance business 10 % ,Local Area Banks 15%

Tier I Capital should at no point of time be less than 50% of the total capital. This implies that Tier II cannot be more than 50% of the total capital.

In Singapore 8% should be Tier I and 4 percent should be Tier II

Capital fund

Capital Fund has two tiers - Tier I capital include
Paid-up capital ,statutory reserves, other disclosed free reserves ,capital reserves representing surplus arising out of sale proceeds of assets. Minus equity investments in subsidiaries, intangible assets, and losses in the current period and those brought forward from previous periods
Tier II capital consists of:
Un-disclosed reserves and cumulative perpetual preference shares, Revaluation Reserves (at a discount of 55 percent while determining their value for inclusion in Tier II capital) General Provisions and Loss Reserves up to a maximum of 1.25% of weighted risk assets: Investment fluctuation reserve not subject to 1.25% restriction ,Hybrid debt capital Instruments (say bonds): Subordinated debt (long term unsecured loans:
Risk weighted assets - Fund Based :

Non-funded (Off-Balance sheet) Items : The credit risk exposure at­tached to off-balance sheet items has to be first calculated by multiplying the face amount of each of the off-balance sheet items by the credit conversion factor. This will then have to be again multiplied by the relevant weightage.

Deposit-taking institutions

Capital adequacy

Regulatory capital to risk-weighted assets

Regulatory tier I capital to risk-weighted assets

Nonperforming loans net of provisions to capital

Asset quality Nonperforming loans to total gross loans

Sectoral distribution of loans to total loans

Earnings and profitability Return on assets

Return on equity

Interest margin to gross income

Noninterest expenses to gross income

Liquidity Liquid assets to total assets (liquid asset ratio)

Liquid assets to short-term liabilities

Sensitivity to market risk Net open position in foreign exchange to capital

Where is the Hole?

When Banks Balance sheet and Income Statement are studied following are the most important points to be taken into consideration.

Nonperforming loans net of provisions to capital - How is performance of the loans, who are not paying and from when they are not paying. How much is the provision against such loans.

NPA is a loan or an advance where, and Provisions on NPA

1- Interest and/ or Installment of principal remain overdue for a period of more than 90 days in respect of term loan.

2- The account remains out of order for a period of more than 90 days in respect of an overdraft/ cash credit.

3- The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted.

4- Interest and/ or Installment of principal remain overdue for two harvest seasons but for a period not exceeding 2 years

5- Any amount to be received remains overdue for a period of more than 90 days in respect of other account.

Asset quality Nonperforming loans to total gross loans

Classification of advances: - The guidelines require bank to classify their advances into four broad categories are as follows:-

a- Standard AssetA standard asset is one which does not disclose any problems and which does not carry more than normal risk attached to the business. Such an asset is not a non-performing asset.

b- Sub Standard Asset A substandard asset is one which has been classified as NPA for a period not exceeding 12 months.

c- Doubtful Asset A doubtful asset is one which has remained NPA for a period exceeding 12 months.

d- Loss of Asset A loss of asset is one where loss has been identified by

Sectoral distribution of loans to total loans – Who are the main customers of Bank and what is the present situation of them. If Bank is heavily involved in Housing Finance then the housing market is down and 28% mortgages are below their loan value. Under this situation the Bank will have to take a loss over the period if market does not improve.

Consumer Loans and Personal Loans – When unemployment is high and many people are under employed this will be affected and so is profitability of the Bank

Earnings and profitability Return on assets- What are main streams or sources of Banks revenue generation and how they will perform in the future is the very important exercise for the investor.