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Tutorial 2 Introduction to Financial Statements of Bank

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Tutorial 2 Introduction to Financial Statements of Bank

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Loo Bee Yeok
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© © All Rights Reserved
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TUTORIAL 2: FINANCIAL STATEMENTS OF BANKS

ICAEW Business Planning: Banking Question


June 2018

You are an ICAEW Chartered Accountant employed in the risk management department of
Mawashi Bank plc (Mawashi).

Mawashi is a UK investment bank that trades in securities and derivatives. Mawashi limits its
exposure to counterparty risk related to over-the-counter (OTC) derivatives by carefully
selecting the counterparties with which it deals. However, to expand its OTC derivatives trading
business, Mawashi intends to increase the number of banks with which it trades.

Mawashi’s approval of counterparties is based on both external credit ratings and internal
analysis. The decision regarding acceptance of new counterparties will be taken at the next
Credit Risk Committee meeting.

One of the banks under consideration is Geri Bank Ltd (Geri). Mawashi anticipates that if Geri
becomes an approved counterparty, it would carry out a significant amount of business with
Mawashi.

You have been provided with the following information from Geri’s most recent annual report:
statement of financial position (Exhibit 1); statement of profit or loss (Exhibit 2); and Capital
Requirement Directive IV (CRD IV) regulatory capital position (Exhibit 3). You have also
obtained a summary of Geri’s operations from a research analyst in Mawashi’s equities division
(Exhibit 4).

Requirements

1 Analyse the financial and operational information in Exhibits 1 to 4 to assess whether


Mawashi should approve Geri as an OTC counterparty. Focus on Geri's performance,
funding and regulatory capital position.

2 Identify and explain how Geri’s counterparty risk could be mitigated by Mawashi.

Total: 35 marks

Exhibit 1 – Geri’s statement of financial position as at 31 March


2018 2017
Assets £m £m
Cash and balances at central banks 2,022.2 1,901.7
Loans and advances to banks 594.1 618.4
Loans and advances to customers 13,511.4 14,480.2
Investment securities – loans and receivables 9.7 10.6
Investment securities – available for sale 2,872.7 3,117.4
Investment securities – fair value through profit or loss 291.8 413.5
Derivative financial instruments 336.9 303.7
1
Property, plant and equipment 164.9 222.2
Prepayments and accrued income 20.4 30.8
Total assets 19,824.1 21,098.5

Liabilities
Deposits by banks 5,821.0 1,115.4
Deposits by customers 10,870.1 16,317.3
Debt securities in issue 1,445.8 1,813.5
Other borrowed funds 315.6 246.3
Derivative financial instruments 368.1 375.3
Accruals and deferred income 81.9 108.3
Provisions for liabilities and charges 196.2 254.4
Current tax liabilities - 0.2
Total liabilities 19,098.7 20,230.7

Capital and reserves attributable to equity


Ordinary share capital 16.1 16.1
Share premium account 1,531.0 1,524.3
Retained earnings (888.8) (736.7)
Available for sale reserve 27.1 39.5
Cash flow hedging reserve 40.0 24.6
Total equity 725.4 867.8
Total liabilities and equity 19,824.1 21,098.5

Exhibit 2 – Geri’s statement of profit or loss for the year ended 31 March
2018 2017
£m £m
Interest receivable and similar income 523.8 583.3
Interest expense and similar charges (367.4) (370.9)
Net interest income 156.4 212.4
Fee and commission income 82.9 93.7
Fee and commission expense (33.8) (42.7)
Net fee and commission income 49.1 51.0
Income from investments 0.4 0.7
Operating income 205.9 264.1
Operating expenses (355.9) (343.2)
Provision for customer redress (15.9) (95.8)
Total operating expenses (371.8) (439.0)
Operating losses before net impairment gains (165.9) (174.9)
Net impairment gains on loans and advances 4.4 34.5
Loss before tax (161.5) (140.4)
Income tax 9.4 (8.7)
Loss for the year (152.1) (149.1)
Exhibit 3 – Geri’s CRD IV regulatory capital position at 31 March
2018 2017
CET1 capital after regulatory adjustments (£m) 659.60 816.90
Risk weighted assets (RWA) (£m) 5,035.00 5,270.26
CET1 Ratio (CET1/RWA) 13.10% 15.50%
Total capital ratio (Total capital/RWA) 17.57% 19.77%
Leverage ratio (Tier 1 capital/Total exposure) 3.20% 3.80%

Exhibit 4 – Summary of Geri’s operations from Mawashi’s research analyst

Geri is a small UK bank, listed on the London Stock Exchange. It focuses on retail banking
activities in the UK and other European countries.

In February 2017, Geri was involved in a financial scandal involving excessive charges and
significant underpayment of interest on numerous UK customer deposit accounts. These
events led to the resignation of Geri’s chief executive and some members of senior
management. Geri received considerable adverse media coverage related to these events. To
mitigate the loss of customers in the year ended 31 March 2018, Geri offered higher deposit
interest rates as a ‘loyalty bonus’ to its existing customers.

In April 2017, Geri recruited a new management team. The new team’s strategy has been to
reduce costs through extensive branch closures, combined with developing a more
comprehensive online banking service. In the financial year ending 31 March 2018, this
strategy led to non-recurring operating expenses of approximately £100 million.

In the financial year ended 31 March 2018, Geri also suffered losses related to interest rate
and currency risk that it had not actively managed. Geri’s management team intends to
increase the extent to which Geri actively manages these risks through greater use of OTC
derivatives.

At 31 March 2018, Geri’s minimum common equity tier 1 (CET1) requirement, including
individual capital guidance and CRD IV buffers, was set at 12.75%. The management team
has announced that it intends to improve Geri’s capital position by raising £5,000 million
through an ordinary share issue in the final quarter of 2018.

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