Financial Performance

Analysis of a Bank
 Financial Statements and Statutory
Reports
• Directors’ report
• Independent auditor’s report
• Balance sheet
• Profit and loss account
• Cash flow statement
• Schedules to the financial statements
• Basel III disclosures
 Financial Statements and Statutory
Reports
• Independent auditor’s report for consolidated financials
• Consolidated balance sheet
• Consolidated profit and loss account
• Consolidated cash flow statement
• Schedules to the consolidated financial statements
• Certificate on Corporate Governance
• Corporate Governance
• Shareholder information
 Bank Assets

• Cash and Balances with RBI:CRR (a portion of NDTL- Net demand

and time liabilities)
• Balances with Banks and Money at Call and Short Notice
:India/Outside India
• Investments
• Categories; Government Securities, Other approved securities, Shares,
Debentures and Bonds, and other investments
• Securities are held to earn interest and help meet liquidity needs,
administration cost is low
• To be classified at the time of purchase as held-to-maturity (HTM), held for
trading (HFT), or available for sale (AFS)
• HTM in B/S at amortized cost, HFT are marked to market, all others are AFS
 Bank Assets
• Loans/ Advances: Net of provisions
• The major asset, generate the greatest amount of income,
exhibit the highest default risk and are relatively illiquid.
• Reporting Format
• Bills purchased/ Discounted, Cash Credit/ Overdraft, Term
Loans, Securitization, Finance lease and hire purchase
receivables
• Secured by tangible assets, covered by bank or government
guarantees and Unsecured
• Priority sector, Public sector, banks and others
• For reporting to RBI, loans are categorized into Standard
Assets, Doubtful Assets and Loss Assets,
• Loans may be categorized according to the use of proceeds;
real estate, commercial individuals, agricultural etc
• Banks are reporting loan exposure to sensitive sectors i.e.
Capital market, Real Estate and Commodities.
 Bank Assets (Contd….)
• Fixed Assets and Other assets
• Bank premises and equipment, interest receivable, prepaid
expenses, other real estate owned, and customers' liability
to the bank
• Other Assets
• Inter office Adjustments
• Interest Accrued
• Tax paid in advance
• Stationery and Stamps
• Non- Banking assets acquired in satisfaction of claims
• Others: Advance for Capital assets, Deferred tax asset,
Outstanding fees and other income
• Contingent Liabilities
 Bank liabilities
• Equity Capital: Preference, Rights, GDR, ESOP etc.
• Reserves:
• 25% of annual profit to statutory reserve account,
• In addition they can have General reserves, Revaluation reserves,
Capital reserves etc.
• Investment Fluctuation Reserve, Foreign currency translation account
• Demand deposits
• Transactions accounts that pay no interest
• Savings Bank Deposits
• Term Deposits and Certificate of Deposits
• Borrowings : RBI, other banks, IPDI(To enable banks to raise additional
capital, RBI allows banks to raise capital by issue of innovative perpetual
debt instruments and debt capital. ... , others (Tier II)
• Other Liabilities and Provisions: Bills payable, Interest Accrued,
Contingent provision against standard assets
 The Income Statement
• Interest income/ Interest earned (II)
• Noninterest income / Other Income (OI)
• Interest expense/ Interest Expended (IE)
• Interest income less interest expense equals
Net Interest Income (NII)
• Noninterest expense/ Operating Expense (OE)
• noninterest expense usually exceeds noninterest income
such that the difference is labeled as bank's Burden
• Loan-loss provisions/ Provisions and Contingencies (PL)
• represent management's estimate of potential lost revenue
from bad loans
• Profit
• Appropriation: Transfer to statutory reserve, General
Reserve, Capital Reserve etc
 The Income Statement
• Interest income earned (II): Interest/ discount on
advances/bills, Income on Investments, Interest on
Balances with RBI and other inter bank funds

• Other Income/ Non-interest income (OI):

Commission, exchange and brokerage, Profit/Loss on
Sale of Investments, Profit/Loss on Revaluation of
Investments, Profit/Loss on Sale of land buildings
and other assets, Profit/Loss on exchange
transactions, Income earned by way of dividends
from subsidiary or joint ventures
 The Income Statement
• Interest expense/ Expended (IE)
• Interest on Deposits, Interest on RBI/ inter-bank borrowings
and others,
• Non-interest expense/ Operating Expense (OE)
• Payment to and provision for employees, rent taxes and
lighting, printing and stationery, advertisement and
publicity, depreciation on bank’s property, Director’s fees,
allowances and expenses, auditors fees and expenses, law
charges, postage, telephones etc, repairs and maintenance,
DMA expenses, Insurance etc
• Non-interest expense usually exceeds non-interest income
such that the difference is labeled the bank's burden
• Provisions and Contingencies (PL)
• represent management's estimate of potential lost revenue
from bad loans, provisions for investments, advances and
income tax
 Contingent Liabilities
• Claims against the bank not acknowledged as Debts
• Liability for partly paid investments
• Liabilities on account of forward exchange contracts
• Guarantees given on behalf of constituents
• Acceptances, endorsements and other obligations
• Currency Swaps
• Interest Rate Swaps, currency options and interest
rate futures
• Other items for which bank is contingently liable
 Other useful information
• Capital Adequacy Ratio
• Business/ Information Ratios: Interest income to working
funds, non-interest income to working funds, operating profit
to working funds, ROA, Profit per employee, Business per
employee; (working funds: average of total assets, Business:
average deposits plus average advances)
• Information about Business and Geographical
segments: Retail, Wholesale, Treasury and others (hire
purchase and leasing etc); Domestic and Foreign operations
 Other useful information
• Maturity pattern of Assets and Liabilities
• Securitization details
• ESOS (Employee Stock Options Scheme)
• Details of Subordinated Debt/ Contingent Liabilities
• Investments Categorization
• Details of Advances: Lending to sensitive sectors, Capital
markets, Real estate (direct and indirect), details of single
borrower limit and borrower group limit, risk category wise
country wide exposure, Reporting of NPA, provisioning for NPA
and Standard assets
• Concentration of Deposits, advances, exposure and
NPA’s: twenty largest depositors, non-bank borrowers
 Rate
Bank Performance Model Composition (mix)
Interest
Returns
Returnsto
to
Shareholders Volume
Shareholders
ROE INCOME
ROE==NI
NI//TE
TE Fees and Serv Charge
Non Interest Trust
Other
Return to the Bank
ROA = NI / TA
Rate
Interest
Composition (mix)
Volume
EXPENSES
Salaries and Benefits
Overhead
Occupancy
Degree of Leverage
Prov. for LL Other
EM =1 / (TE / TA)
Taxes
 Analyzing Bank Performance with Financial Ratios

• ROE is composed of two parts:

• Return on Assets (ROA = NI / TA),
• represents the returns to the assets the bank has invested in
• Equity Multiplier (EM = TA / TE),
• the degree of financial leverage employed by the bank
• Other profit measures
Net interest margin
NIM = (Total interest income - Total interest expense)/Total assets
 Analyzing Bank Performance with
Ratios
• Profit ratios
• Unraveling profit ratios
ROE = ROA x TA/TE (total assets/total equity or equity
multiplier).
Thus, by decreasing equity, a bank can increase ROE for any
given level of ROA.
ROE = NI/OR x OR/TA x TA/TE (where OR is operating
revenue)
The NI/OR ratio is the profit margin, while OR/TA reflects asset
utilization. If asset utilization and equity multiplier did not change,
the profit margin must have increased due to cost savings that
increase this ratio.
 Decomposition of ROA
Since NI is equal to (II+OI)- (IE+ OE+ Prov), dividing both
sides by TA, we get

• ROA = (NI ) (II -IE) (OI -OE) Provisions

_______= _____ + ________ - _________
TA TA TA TA
Where,
• NI is Net Income or Net profit after tax
• II is Interest Income
• IE is Interest Expenditure
• OI is Other Income or non interest income
• OE is non interest expenses
• TA is Total Assets
 Decomposition of ROA
• The first ratio of the last equation can be further
subdivided in to NIM and Earnings Base

(II - IE) (II - IE) Earning Assets

_______ = _________ X ____________
TA Earning Assets TA
 Decomposition of ROA
• NIM can be further decomposed into

Interest Income - Interest Expenses × Interest Bearing liabilities

Earning Assets Interest bearing liab Earnings Assets
(1) (2)

(1) =Average yield on earning assets

(2) = Average cost of funds
Spread = (1) – (2)
• Other ratios like Asset utilization and Efficiency ratio
Non - Interest Expenses
Efficiency Ratio= ---------------------------------------------------
Net-Interest Income + Non - Interest Income
 Aggregate profitability measures

• Net interest margin

• NIM = NII / Earning Assets (EA)
• Spread
• Spread = (Int Income / EA) - (Int Exp / Int bear. Liab.)
• Earnings base
• EB = EA / TA
• Burden / TA
• (Noninterest Exp. - Noninterest Income) / TA
• Efficiency ratio
• Non int. Exp. / (Net int. Inc. + Non-int. Inc.)
 Risk Return Trade off

• Liquidity Risk = Short term securities/ Deposits

• Interest Rate Risk = Interest Sensitive Assets/ Interest
Sensitive Liabilities
• Credit Risk = Provisioning / Assets
• Market Risk
• Capital Risk = Capital / Assets
 Analyzing Bank Performance with
Ratios
• Risk ratios
• Capitalization
Leverage ratio
Total equity/Total assets
Total capital ratio
(Total equity + Long-term debt + Reserve for loan
losses)/Total assets

Note: book values and market values are likely to be different and
yield different results.
 Analyzing Bank Performance with
Ratios
• Risk ratios
Asset quality
Provision for loan loss ratio
= PLL/TL (provision for loan losses/total loans and leases)
Loan ratio
= Net loans/Total assets
Loss ratio
= Net charge-offs on loans (gross charge-offs minus
recoveries)/Total loans and leases
Reserve ratio
= Reserve for loan losses (reserve for loan losses last year
minus gross charge-offs plus PLL and recoveries)/Total
loans and leases
Nonperforming ratio
= Nonperforming assets (nonaccrual loans and restructured
loans)/Total loans and leases
 Analyzing Bank Performance with
Ratios
• Risk ratios
• Operating efficiency (cost control)
Wages and salaries/Total expenses
Fixed occupancy expenses/Total expenses
• Liquidity
Temporary investments ratio
= (Fed funds sold, short-term securities, cash, trading account
securities)/Total assets
Volatile liability dependency ratio
= (Total volatile liabilities - Temporary investments)/Net loans
and leases
Note: This ratio gives an indication of the extent to which “hot”
money is being used to fund the riskiest assets of the bank.
 Analyzing Bank Performance with
Ratios

• Other financial ratios

• Tax rate = Total taxes paid/Net income before taxes
• Rupee gap ratio
=Interest rate-sensitive assets – Interest rate-sensitive liabilities
Total assets
where rate-sensitive means short-term with maturities of less than one
year (or repriced in less than one year).