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RETAIL BANKINGACADEMY

210.Financial Management

Course Code 210 - Financial Management

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RETAIL BANKING II


Course Code 210Financial Management

Introduction

Analysis of Bank Financial Statements

This module covers five areas:

1. Key principles of bank financial statements

2. Structure of bank financial statements

3. Analysis of bank financial statements using the CAMELS framework (Capital, Asset Quality, Management, Earnings and Profitability, Liquidity and Market Sensitivities)

4. Drivers of bank profitability

5. Importance and relevance of bank capital

The module focuses on retail banking. The financial management module is intended for participants with cross-functional skill sets, covering both financial and non-financial retail banking staff.

The remainder of this module is organised as follows. Chapter 1 presents and discusses typical financial statements (income statement and balance sheet) for a retail bank. A maturity analysis is also considered. Chapter 2 analyses the bank’s financial statements using a CAMELS framework. This module concludes with a summary and multiple choice questions.


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Chapter 1: Financial Statements

Examples of a generic income statement and a balance sheet for a bank are provided below. When analysing financial statements, the comparison of results and percentage changes between years (trend analysis) is critical as well as assessing the performance of the bank for the current year. The reference years are 2012 and 2011.

Income Statement (Generic)

Income Statement ($mlns) 2012 2011 Change

Interest Income 250 225 (250-225)/225 = 11.1%

Interest Expense 165 145 13.8%

Net Interest Income 85 80 6.3%

NII as a % of interest Income 34% 35.5% (34-35.5)/35.5 = (4.2%)

Non-Interest Income

Fees & Commission

Income 5 3 66.7%

Net Gain/(Loss) on sale of securities 3 3 0.0%

Net Gain/(Loss) on sale of FI 4 2 100%

FX Gains/(Losses) 3 -2 250.0%

Other Operating Income 2 2 0.0%

Total Non-Interest Income 17 8 112.5%

Total Income 102 88 30.7%


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Payroll Costs 30 27 11.1%

Admin & General 15 13 15.4%

Depreciation 2 2 0.0%

Fees & Commission 3 3 0.0%

State Deposit Insurance 3 3 0.0%

Other Operating Expense 2 2 0.0%

Total Operating Expense 55 50 10.0%

Operating Income 47 38 23.7%

Income after LLP 27 23 17.4%

Cost to Income Ratio(Total OPEX/ Total Operating Income)

54% 56.8% (4.9%)

Addition to Loan Loss Provision (LLP) 20 15 33.3%

Income Before Taxation 27 23 68.2%

Taxation 5 4 25.0%

% of Income before Taxation 18.5% 17.3% 6.9%

Net Income after Tax 22 19 15.8%

210.1: Generic Income Statement

Relevant points are identified as follows.

Income Statement Item Comments

Net Interest Income The Net Interest Income (NII) line shows the total interest spread achieved by the bank from contributions made across all business units. Disclosure information provided in published bank financial statements will provide further breakdown between business units (retail, corporate, trading) of net interest income performance. Internal management information will drill down further and show the relative operating performance between products and services within business units. For example, emphasis may be on the net interest income earned on consumer loans, automobile loans, residential mortgages and other loans.

Using the data provided below, the net interest margin for 2012 is 34%, down by one percentage point over 2011. This represents a high margin for banks operating in a competitive and mature environment, and is more typical of margins earned by banks in emerging market economies.


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Non-Interest Income All Non-Interest Income items are grouped together after the Net Interest Income Margin.

A major component of a bank’s profitability represents fees and commissions that are charged across the complete range of products and services, both on balance sheet (such as loans) and off balance sheet (guarantees, performance bonds).

The ratio of Non-Interest Income to Total Operating Income is important to calculate and review. In 2012, the ratio was 16.7% (17/102) up from 9.1% (8/88) in 2011.

Total Operating Expense

All Operating Expense items are grouped together under this heading. The total of such costs is scrutinised closely by analysts as the total level of operating costs provides an indication of the efficiency and productivity of a bank when compared with prior year performance, and between a peer group.

Cost to Income Ratio The ratio is calculated as Total Operating Expense (OPEX)/Total Operating Income. For 2012, the ratio was 54.5% (2011 56.8%). Although an improvement on 2011, the resultant ratio for 2012 may still be considered high. A more normal range would be between 45% and 55% for efficient banks and more than 55% for less efficient ones.

The existence, or introduction, of a large branch network to serve retail customers may drive the Cost to Income Ratio upwards in the short to medium term. As such, banks may seek alternative and lower cost channels (internet or remote banking) to service retail customers to constantly manage this ratio downwards.

Addition to Loan Loss Provision (LLP)

For year end and periodic reporting purposes, a bank will need to assess its loan book and make a loan loss provision or reserve against the bank’s loan book for doubtful and bad loans. This is commonly referred to as the Addition to Loan Loss Provision included in the income statement and LLP for bad or impaired loans in the balance sheet.

Different accounting techniques and approaches for how such provisions should be calculated exist. For example:

• Local national and statutory accounting principles

• Financial Statements in accordance with IFRS

• Regulatory rules set by Central Banks

The course module covering Risk Management, and specifically for credit risk, explains how such provisions may be calculated.

In this example, for 2012, the Addition to LLP is up from 2011. In isolation, this may indicate that the underlying quality of the loan book has deteriorated. However, a full and accurate interpretation of this result against the prior year comparative performance requires a more in-depth analysis of many other factors, including the volume of risk assets, cost of funds and yields.

The Addition to LLP made during the year will vary and is a function of many variables, both external and internal. The latter may include sub-optimal lending decisions and weak credit risk management.


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($mlns) 2012 2011 % Change

Assets

Cash and Central Bank 250 300 -17%

Due from Fin. Institutions 150 100 50%

Trading Portfolio 150 125 20%

Available for sale securities 100 50 100%

Loans to Fin. Institutions 400 300 33%

Loans to Customers (Net)

Corporate 700 600 17%

Retail 1,042 800 30%

Property and Equipment 50 50 0%

Other assets 50 50 0%

Total assets 2,892 2,375 22%

Liabilities

Deposits by Central Bank 150 250 -40%

Deposits by Fin. Institutions 175 250 -30%

Customer Deposits:

Corporate 800 550 45%

Retail 1,350 900 50%

Debt Securities 100 150 -33%

Other Liabilities 50 50 0%

Total Liabilities 2,625 2,150 22%

Shareholder Equity

Share Capital 100 100 0%

Revaluation Reserve 20 0 0%

Retained Earnings 147 125 26%

Total SH Equity 267 225 19%

Total Liabilities + SH Equity 2,892 2,375 22%

210.2: Generic Balance Sheet

Supplementary Information for the Balance Sheet

To understand and analyse the balance sheet, further information is provided on the make-up of the loan book.

The following table provides a breakdown of the loan book between corporate and retail. Total loans are shown gross less the provision (LLP) that has been made to cover actual and potential loan defaults and loan losses. Retail loans comprise 60 percent of the total loan book with a provision for bad loans at 2.7798 percent (2.0 percent for 2011). The bank has a mixed portfolio of retail products, covering consumer loans, auto loans, residential mortgages and other loans.

Figures are provided at the foot of the table for the total amount of non-performing loans, which are defined as loans that are past due or for which interest has not been paid for 90 days or more.


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2012 2011 % Change

Loans

Gross Corporate Loans 720 612 17.6%

Less: Provision 20 12 66.7%

Net Loans 700 600 16.7%

LLP as % of Gross Loans 2.78% 2%

Retail Loans (Gross)

Consumer Loans 300 220 36.4%

Auto Loans 204 130 56.9%

Mortgages 550 450 22.2%

Other Loans 20 20 0%

Sub-Total (Gross) 1,074 820 31%

Less: Loan Loss Provision 32 20 60%

Net Retail Loans 1,042 800 30.3%

LLP as % of Gross Loans 2.98% 2.44%

Total all loans (Net as shown in the Balance Sheet)

1,742 1,400 24.4%

Non-Performing Loans 60 35 71.4%

210.3: Breakdown of the Loan book

The final information provided in support of the balance sheet is a maturity analysis, for 2012 and 2011. The maturity analysis represents an important review for a bank in assessing how a bank manages its relationship between sources of funds and liabilities and how it uses those funds to make lending decisions and commitments and, critically, to maintain adequate liquidity.

The maturity table analyses the asset and liability side of the balance sheet by maturity buckets, according to contractual terms. Typically, the time buckets used are as set out in the example, although longer time maturities beyond five years would be disclosed for the majority of commercial banks. For example, in developed markets, residential loans granted might have original maturities of 25 years. In emerging market economies, when granting long-term loans the maximum tenor of a retail mortgage granted may be a maximum of five years.

Example Bank – Maturity Analysis

2012

<1month 1-6 months

6 months - 1 year

1-3 years

3-5 years

No maturity

Total

Assets

Cash and Central Bank 200 50 250

Due from FI 100 25 25 150

Trading Portfolio 150 150

Available for sale securities

100 100

Loans to FI 100 250 50 400

Loans to Customers


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Corporate 150 250 250 50 700

Retail 50 100 120 250 522 1,042

Property and Equipment

50 50

Other assets 25 25 50

Total Assets 875 700 445 300 522 50 2,892

Liabilities

Deposits with Central Bank

150 150

Deposits by FI 100 75 175

Customer Deposits

Corporate 300 200 300 800

Retail 250 450 450 200 1,350

Debt Securities 50 50 100

Other Liabilities 25 25 50

Total Liabilities 675 950 800 200 0 0 2,625

Mismatch 200 -250 -355 100 522 50 267

Cumulative 200 -50 -405 -305 217 267

210.4: Maturity Analysis 2012 (table)

The figures at the penultimate line at the end of the table disclose the mismatch by period between assets and liabilities. In the short term up to 30 days, the sample bank discloses an excess of assets over liabilities of 200. In the following period of one to six months, liabilities exceed assets by 250. The cumulative maturity position is also disclosed and shows that the bank has some longer-term lending commitments maturing in the three to five-year time period but not matched by an equivalent amount of long-term funding. This represents the classic position of a bank lending long and borrowing short.

Note that on the liability side, shareholder funds are not included as part of the maturity analysis. Where a bank has issued certain financial instruments, such as subordinated loan notes, which are classified under shareholder funds, such notes may have a fixed maturity. In such a situation, a bank may include the loan notes or other fixed-term maturity instrument as part of the maturity analysis. Such instruments are referred to as quasi or hybrid capital. Otherwise, shareholder funds are excluded from the maturity analysis as, by definition, such funding is provided for the long term, has no fixed maturity term and is intended to provide a cushion to absorb unusual and exceptional losses.

The maturity analysis disclosed represents one currency that is typically the currency a bank operates and reports in. Banks will operate with many currencies, and alternative maturity analyses can be prepared focusing on a specific currency. For example, where a bank operates in local currency, euro and USD, a maturity analysis could be prepared for each currency to identify potential currency exposure mismatches. Here is an analysis for the full year 2011 as a comparison with 2012.


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Example Bank – Maturity Analysis

2011

<1 month 1-6 months 6 months - 1 year

1-3 years 3-5 years No Maturity

Total

Assets

Cash and Central Bank 250 50 300

Due from FI 100 100

Trading Portfolio 125 125

Available for sale securities 50 50

Loans to FI 50 250 300

Loans to Customers

Corporate 125 225 225 25 600

Retail 30 70 90 175 435 800

Property and equipment 50 50

Other assets 25 25 50

Total Assets 755 620 315 200 435 50 2,375

Liabilities

Deposits with Central Bank 10 240 250

Deposits by FI 200 50 250

Customer Deposits

Corporate 100 280 170 550

Retail 75 200 400 225 900

Debt Securities 50 50 50 150

Other Liabilities 25 25 50

Total Liabilities 460 845 620 225 0 0 2,150

Mismatch 295 -225 -305 -25 435 50 225

Cumulative 295 70 -235 -260 175 225

210.5: Maturity Analysis 2011 (table)

A graphical presentation is presented below for 2011 and 2012 which can help understand the maturity position in each financial year and the dynamics in terms of changes between the current and prior year.


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Maturity Analysis

Maturity Buckets

Am

ount

2011

2012

210.6: Maturity Analysis (graph)

Open Question

Compare the loan book and analyse the maturity buckets in 2012 compared to 2011. In particular, what risks can you identify?


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Chapter 2: Analysis of bank financial statements using the CAMELS framework

The CAMELS framework is a common methodology used for analysing bank financial statements. CAMELS has six aspects:

• C = Capital Adequacy

• A = Asset Quality

• M = Management Soundness

• E = Earnings and Profitability

• L = Liquidity

• S = Sensitivity to Market Risk

The approach was developed and applied from the early to mid-1980s by USA regulators. It remains applicable today and provides a framework for external analysts and users of financial statements to interpret financial statements covering all financial institutions. The major international rating agencies, Moody’s, Standard & Poor’s and Fitch, all use the basic elements of CAMELS when reviewing a bank and issuing a rating report. For the purpose of this case study, the focus will be on the quantitative aspects of CAMELS, covering Capital Adequacy, Asset Quality, Earnings and Profitability and Liquidity. For completeness, Management Soundness and Sensitivity to Market risks will be addressed, but only in general terms.

CAMELS: Capital Adequacy

Banks require adequate capital levels for the following reasons:

• To provide long-term stable funding (refer to NSFR);

• To act as a buffer to absorb unexpected losses.

From the perspective of bank regulators:

• Adequate levels of capital are required to ensure that the banking system is able to


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function normally when faced with unforeseen events. Again, as the recent financial crisis demonstrated, many banks were under-capitalised leading to a reassessment by regulators of the capital levels that should be held by banks.

• Regulators also require adequate levels of capital to be in place to provide cover for banking risks and losses that emerge due to poor decision making, poor risk management and the taking of excessive risks by management.

• Adequate capital levels should also be in place to provide confidence to depositors to place funds with the bank.

• Finally, national regulators wish to ensure that adequate capital is in place across the banking sector to deal with potential systemic risk. Such risk may occur when one bank defaults and fails, which may lead to a loss of confidence in the market as a whole, causing a domino effect of depositors withdrawing deposits combined with disruption to the wholesale or inter-bank market.

Types of Capital

Bank capital can take many different forms, often driven by country-specific legislation and regulations, or by the Basel Committee on Banking Supervision (Basel). The most common form of capital is equity or common stock. Retained earnings or profits after dividend payments are also classified as shareholder funds and part of capital.

The Basel Committee on Banking Supervision was established in 1987, under the umbrella of the Bank for International Settlements (BIS). The original 12 members comprised representatives from 12 countries’ supervisory bodies. The purpose of the Basel Committee was to evaluate the principles of capital requirements for international banks and to recommend certain principles and proposals on setting minimum standards of capital for financial institutions. A major milestone was reached with the publication in July 1988 of the Basel Capital Accord, or Basel I, on ‘International Convergence of Capital Measurement and Standards’.

The drivers for Basel I were primarily:

• From the mid-1980s, banks were becoming increasingly international with increasing and significant cross-border business happening at the same time they were expanding their merger and acquisition activity. This raised issues for regulators as to how to regulate and supervise banks that had cross-border or even cross-continental reach.

• The 1980s also witnessed international and national banks moving into the emerging market economies of Central and Eastern Europe and Latin America. This trend further increased bank exposures.

• Banking operations became more complex with the launch of derivative products and the expansion of the trading book relative to the banking book. New products included foreign exchange hedging instruments and interest rate swaps and options.

• National regulators adopted different approaches to setting minimum capital standards.The objective was to promote a uniform approach to capital setting, primarily aimed at international banks but where the principles could be taken and applied by national bank regulators.

• Finally, there was a requirement to set minimum capital levels to ensure that banks were capable of absorbing abnormal or exceptional losses that would afford greater protection to depositors.


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The following table lists the most common forms of capital.

Capital Type Comments

Shareholders’ Equity Share Capital or Common Stock

Retained Earnings Earnings and profits retained in the business after payment of dividends to shareholders.

In addition, under national regulations, specific reserves may need to be established, disclosed in the balance sheet and ringfenced for specific uses.

Revaluation Reserves Periodic market revaluations on assets or equity investments held by the bank. For example, a revaluation reserve resulting from an upward move in the market value of the bank’s own buildings.

Preference Shares and any form of Preferred Stock

Preference shares have priority over common equity for payment of dividends. Preference shares can be cumulative or non-cumulative depending on whether dividend payments not paid in any year are rolled over and accumulate for payment in subsequent years.

Subordinated Long-Term Debt

A form of quasi or hybrid-capital that can be issued by a bank for different maturity periods, and which pays a fixed or variable interest rate to bondholders. Subordinated loans rank after other creditors.

Other Financial Instruments Other forms of financial instruments have been developed and are in issue that may be classified as capital. For example, Convertible Bonds.

210.7: Common forms of capital

CAMELS: Asset Quality

Asset quality assesses whether there is loss of value or potential loss of value (referred to as an impairment of an asset category or individual items) within an asset category. The quality of a banking asset can decline for many reasons including:

• Loan defaults by individuals on interest or principal amounts due on personal loans and mortgages. This equates to credit risk. High loan default rates may be a function of poor lending decisions, weak internal credit risk management, inadequate diversification of the loan portfolio and/or a function of the prevailing economic and market conditions.

• Reduction in the value of certain trading instruments such as a foreign exchange position, or a decrease in the value of a security. This equates to Market Risk. For example, if not hedged, a bank could be subject to foreign exchange losses on retail loans issued to buy automobiles but denominated in a foreign currency.

• Potential or realised loss due to a breakdown in the risk management and internal control systems of a bank. This equates to Operational Risk.

Banks must assess each balance sheet asset category to determine whether there has been a loss of value. Both on-balance sheet assets and off-balance sheet assets need to be included in the assessment. Impairment provisions made against specific asset categories result in a reduction to banking profits and should be incorporated in the way loan products and services are priced. To the extent that a bank suffers abnormal or exceptional losses, a bank’s capital should provide the ability to absorb such losses.

For the retail loan book, which may comprise several thousand individual loans, certain techniques and approaches have been developed to calculate loan default rates and the resultant addition


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to the loan loss provision. The approaches and techniques used are covered as part of the Risk Management Course.

The methodology used in determining a provision for loan losses is often set by the Central Bank as the regulator. National and/or International Accounting Standards also set out rules and principles for how such provisions are to be calculated and disclosed. In many countries, the reserve for loan losses, calculated for Central Bank reporting purposes, may be different from that used in the financial statements prepared either under national or international accounting standards.

The relationship between the income statement and the balance sheet and impairment charge is shown overleaf.

Income Statement (example)

2012 2011

Net Interest Income Margin before addition to LLP provision 500 450

Addition to LLP 25 17

Net Interest Income Margin after impairment provision 475 433

210.8: Income Statement

Balance Sheet (example)

Retail Loan Portfolio 2012 2011

Total Retail Portfolio (Gross) 1,500 1,200

Balance of Loan Loss provision at beginning of the prior year (75) (58)

Add: Addition to LLP (25) (17)

Total Balance Sheet LLP at year end (100) (75)

Total Retail Portfolio (Net after LLP deduction)

Total Retail Portfolio (Net after LLP deduction) 1,400 1,125

210.9: Balance Sheet

Banks experience non-performing loans. Such loans are defined as loans that are past due, or for which interest and/or principle has not been paid for 90 days or more. A comparison is usually made between the level of non-performing loans and the total provision included as at the balance sheet date.

For example:

2012 2011

Total of Non-Performing Loans 95 78

Balance Sheet LLP at year end 100 75

Ratio of LLP to Non-Performing Loans 105% 96%

210.10: Loans Comparison

For 2012, the provision more than covers the total of non-performing loans. For 2011, the ratio is marginally below 100 percent. In this case, the conclusion can be reached that in broad terms the bank has adequate provisions in place to cover non-performing loans. However, events and circumstances change rapidly, requiring banks to constantly monitor and update their non- performing loan book and associated provisioning.

There are specific measures used for assessing and analysing asset quality that is explained overleaf by way of an example. In particular, it is important to assess the level of provisions made


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for actual and potential loan losses against bank competitors to see whether the bank is doing better or worse than its identified peer group.

CAMELS: Management Soundness

Management soundness is a more qualitative measurement of the quality, experience and ability of bank management to undertake their duties on behalf of, and in the interests of, all stakeholders. A range of factors are taken into consideration in determining management soundness. They include:

• Background, composition and experience of the Board of Directors, or in the case of a two-tier structure, for the Supervisory Board and Management Board.

• Management’s declared business strategy, and whether the strategy may be construed as aggressive and high-risk or conservative and low-risk.

• Management’s approach to implementing robust risk-management policies and practices that are ‘in place, fit for purpose and working as intended’. Risk management extends to Credit Risk, Market Risk, Liquidity risk and Operational Risk combined with effective asset and liability management.

• Past record in delivering consistent returns on equity for shareholders and at levels equal to or better than their peers.

• Compliance with Corporate Governance best practices (e.g., OECD).

CAMELS: Earnings and Profitability

A number of earnings and profitability measures exist and are deployed specifically for banks by management, analysts and rating agencies. Profitability ratios calculated for the total bank position may be analysed further by business lines (Retail, Corporate, and Treasury) and by defined products and service areas. Profitability ratios for a bank should be calculated and compared with prior years to identify and detect trends. Benchmarking and comparative analysis between competitors is also important to determine whether the bank is doing better or worse than its direct competitors or a peer group. High and consistent levels of profitability are attractive to investors and depositors, but may be indicative of a higher level of risk taking adopted by management.

The objective is to achieve sustainable growth in earnings and across all business lines. The relevant factors that should be taken into account when assessing aspects of profitability include:

• The need to assess and quantify absolute growth levels year on year and to understand the sources of profitability growth. For example, an increase in profitability of the Retail loan book may be due to an absolute increase in the loan book coupled with increased spreads secured between cost of funds and the interest and fees earned on the retail loan portfolio.

• The ability of the interest income margin to absorb the first loan losses through the addition to LLP and the build-up of an adequate LLP in the balance sheet to provide a cushion for expected loan losses based on past experience. Note that provision for loan losses acts as a reserve for both non-performing loans plus expected losses on current loans that are expected to occur in the future based on past knowledge and events.

• A series of profitable years retained earnings in the business adds to the bank’s capital base. This provides a cushion to absorb exceptional losses in any one year, while allowing a bank to undertake more business by expanding the asset side of their business. The bank also becomes a more attractive proposition for longer-term and more stable finance.

• A series of profitable years of sustainable growth in earnings assists in securing better external credit ratings. Improved ratings allow the bank to attract funds at marginally better


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rates, thus contributing to a lower cost of funds.

Earnings and profitability indicators are set out and described in the example below together with the key drivers of bank profitability.

CAMELS: Liquidity

Liquidity is defined as “the ability to fund increases in assets, to meet obligations as they become due without incurring unacceptable losses*”.

A bank needs to find the optimal balance between profitability and liquidity. This activity is the main role of the Asset Liability Committee in conjunction with Treasury. Investing and lending all sources of finance on the asset side of the balance sheet long term and/or into illiquid forms of assets may secure high returns but leave the bank exposed to potential liquidity shortfalls. For example, to cover a gap following the withdrawal of a significant amount of deposits, or constraints faced in raising short-term liquidity on the inter-bank market.

Banks maintain their liquidity positions through the following mechanisms:

• Holding cash balances.

• Amounts held on deposit with the Central Bank that can be accessed at short notice.

• Assets that can be easily converted into cash. For example, trading securities held for sale, assuming there is a readily available market.

• Having ready access to Central Bank support and funding lines.

• Having available committed but undrawn funding lines from other financial institutions, banks practice a range of liquidity management techniques to ensure that liquidity levels are kept within pre-agreed limits laid out in internally agreed risk management policies approved by the appropriate management body. Such a body may be the Management Group or a Committee of the Management Group, referred to as the Asset and Liability Committee (ALCO).

Liquidity management is a continuous process operating on a daily cycle to forecast short-, medium- and longer-term liquidity gaps, and to identify actions needed to meet any predicted liquidity shortfall. For regulatory reporting purposes, banks are required to monitor their liquidity position using a range of ratios and indicators prescribed by Central Bank supervisors and to report on those ratios on a daily, weekly and monthly basis. Action is required by a bank where actual reported ratios deviate from pre-agreed limits.

The financial crisis of 2008 to 2009 witnessed a number of cases where financial institutions experienced severe liquidity problems. The situation led to major intervention by Central Banks in many countries in response to the virtual closure of the wholesale and inter-bank market preventing access by banks to meet short-term funding needs. Accordingly, international and national regulators are now paying greater attention to liquidity requirements under both normal bank conditions and, critically, in stressed scenarios.

Key reasons for banks experiencing liquidity issues in 2008/2009 included:

• The emergence of an international global financial crisis giving rise to a general loss of market confidence.

• Contagion stemming from certain banks defaulting, resulting in a number of bank failures requiring intervention by Central Banks with varying forms of rescue packages.

• In certain cases, loss of confidence by depositors leading to an excessive run-off in deposits.

* Principles for Sound Liquidity Risk Management and Supervision, BCBS, September 2008.


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• Assets classified as short-term on the balance sheet were not as liquid as originally forecast. Or, significant discounts or ‘haircuts’ were required to realise short-term asset sales.

• Loan book growth not matched by stable long-term funding.

• An over-dependence on unstable and short-term funding, including the wholesale or inter-bank market, repos and short-term commercial paper.

• Committed but unused lines of credit being drawn down in full by customers.

• Margin calls and other calls on funds to support the bank’s trading book. Exposure to off-balance sheet liabilities requiring funding support, for example, securitisation vehicles.

Examples of liquidity measures are provided in an example below.

CAMELS: Sensitivity to Market Risk

From the 1980s onwards, major international banks entered into riskier transactions. Such transactions had the potential to significantly increase banks’ exposure to Market Risk if not fully understood and managed. Market risk is defined as risks related to changes in prices of tradable financial instruments, including exchange rate and interest rate risks and market prices on available for sale trading securities and bonds.

A commercial bank operates a banking book and a trading book. The banking book comprises mainly the loan portfolio where credit risk management is key to ensuring the quality and performance of the underlying loan portfolio.

The trading book comprises financial instruments where there is continuous exposure to market risk. Typically all trading book items are marked to market on a daily basis to determine the overall loss or profit. A linkage exists between the banking and trading book, as the bank’s trading arm will undertake certain hedging activities in respect of interest rate management on the loan portfolio.

The size and scale of trading books varies significantly between banks, depending on the business and financial strategy adopted by the bank. Historically, trading operations were undertaken as part of core Treasury operations in support of the banking book, but have since evolved and taken on more significance as a proportion of the total business undertaken by financial institutions.

Financial Analysis – Example of Standard Bank

The above sections have outlined the core principles of the CAMELS framework. In the following section, the principles are applied to the sample set of financial statements provided towards the front of these course notes. Note that the example provided is simplified and does not fully reflect all of the requirements of Basel III in terms of qualifying capital and potential adjustments and the calculation of risk-weighted assets to reflect credit, market and operational risk. The purpose of the example is to convey the principles of capital adequacy calculation and assessment.


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Capital Adequacy

The following three capital ratios are used to assess the level of capital for a bank.

1. 2012 Result 2011 Result

Shareholder Equity divided by Total Assets 9.2% 9.5%

This ratio provides a broad measure of the total shareholder funds (equity plus reserves) in relation to total assets. It is defined as the ‘leverage ratio’ and must be at least 3% to comply with Basel III.


Total Assets divided by Shareholder Equity 10.8 10.6

This ratio or multiple is the inverse of the first ratio, and indicates how many times the asset base covers the capital base. The higher the figure the weaker the capital position of the bank. Basel III stipulates a maximum value of 33 for this ratio.

3. Tier 1 Capital Adequacy Ratio 2012 Result 2011 Result

Shareholder Equity divided by Risk-Weighted Assets

14.4% 15.7%

The capital adequacy ratio is a key measure used by banks across all jurisdictions. Different approaches may be set by national regulators in determining how the capital adequacy ratio should be calculated. This example is based on the Basel III principles taking into account credit risk with respect to the example balance sheet. Basel sets a minimum capital adequacy requirement of 7%. In this example, the ratio of 14.4% for 2012 is representative of a well-capitalised bank. The calculation of this capital adequacy ratio is set out below.

210.11: Capital Ratios

Step 1: Compute Risk-Weighted Assets

The following two tables set out the computations for calculating the total risk-weighted assets of the example bank. Risk-weighting percentages will vary over time based on the quality of underlying assets in each asset category

2012 Risk Weight RWA

Assets

Cash and Central Bank 250 0% 0

Due from FI 150 20% 30

Trading Portfolio 150 80% 120

Available for sale securities 100 35% 35

Loans to FI 400 20% 80

Loans to Customers

Corporate 700 100% 700

Retail – Mortgages 540 40% 216

Retail – Other loans 502 100% 502

Property and Equipment 50 100% 50

Other assets 50 100% 50


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Total Assets 2,892 1,783

2011 Risk weight RWA

Assets

Cash and Central Bank 300 0% 0

Due from FI 100 20% 20

Trading Portfolio 125 80% 100

Available for sale securities 50 35% 17

Loans to FI 300 20% 60

Loans to Customers

Corporate 600 100% 600

Retail – Mortgages 440 40% 176

Retail – Other loans 360 100% 360

Property and Equipment 50 100% 50

Other assets 50 100% 50

Total Assets 2,375 1,433

210.12: Computations for calculating risk-weighted assets

The risk-weighting factors are derived from the Basel framework that provides a classification system reflecting credit, market and operational risk of asset categories and counterparties. For example, cash held with the Central Bank is ‘risk free’ and attracts a 0 percent weighting. In this example, loans to corporations are all given an average 100 percent risk weighting.

Note that the risk weighting applied to residential mortgages is 40 percent. This weighting assumes that the mortgage loan book is secured by the bank with the underlying asset value of the property.

Total shareholder equity for 2012 is 267 and 225 for 2011. The resultant capital adequacy ratio for 2012 is 257/1,783 = 14.4 percent and 15.7 percent for 2011. The ratio exceeds the minimum 7 percent required Core Tier 1 ratio but there remains one more test that introduces the concept of quality of capital.

Step 2: Determine whether the bank has adequate capital

The following calculations are required to see whether this minimum is achieved.

Capital 2012 2011

Common Equity Tier 1 (CET1)

Common Equity

Retained Earnings

100

157

100

125

CET 1 257 225

Tier 2 Revaluation Reserve 10 0

Total Tier 1 + Tier 2 267 225

Common Equity Tier 1 2012 2011

Total Risk-Weighted Assets 1,783 1,433

Total RWA x 7% 125 100

Actual CET 1 257 225

210.13: Capital adequacy calculations


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Tier 1 capital is sometimes called ‘going-concern capital’ in that it permits the bank to continue its future activities and reduce the chance of insolvency. Tier 2 capital is called ‘gone-concern capital’ in that it would help to protect claims of depositors and higher quality creditors. As of 1 January 2019, the Tier 1 capital ratio must be at least 7 percent of RWA at all times. Regulators may add Tier 1 capital requirements for certain banks, i.e., an additional 2.5 percent for Significant International Financial Institutions (SIFIs).

For 2012 and 2011, the totals for CET 1 capital of 257 and 225 are more than adequate to pass the 7 percent test.

Asset Quality

The following supplementary information is provided with respect to the loan book.

Loan Portfolio 2012 2011

Retail:

Consumer Loans 300 220

Auto Loans 204 130

Residential Mortgages 550 450

Other Loans 20 20

Gross Retail Loan Portfolio 1,074 820

Less: Loan Loss Provision (32) (20)

Net Retail Loan Book 1,042 800

Gross Corporate Loans 720 612

Less: Loan Loss Provision (20) (12)

Net Corporate Loan Book 700 600

Total Loan Book (Net) 1,742 1,400

Non-Performing Loans (NPL) 2012 2011

Retail Loan Portfolio 55 45

Corporate Loan Portfolio 25 15

Total NPL 80 60

210.14: Loan Portfolio comparisons

Using information from the balance sheet, income statement and supplementary information, four ratios may be calculated to assess asset quality. Note that the total loan amounts are used for calculation purposes. The same ratio analysis can be equally applied to the retail loan portfolio, and for separate elements of the loan portfolio, covering residential mortgages, auto loans and other consumer loans.


Addition to LLP divided by Loan Portfolio 1.1% 1%

This ratio assesses the degree to which the LLP addition in the Income Statement as a provision for loans which may potentially default or have defaulted indicates a problem with the loan book. A ratio of more than 3% indicates a high charge and potentially a profitability issue for the bank. In this case, the actual ratio of 1.1% for 2012 is well within acceptable limits.


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Provision for Loan Losses as a % of Loan Portfollio

2.9% 2.2%

This ratio provides an indication of the quality of the loan book, when compared with the prior year and/or with a peer group. A ratio of greater than 3% indicates that the quality of the loan book may be deteriorating. In this example, the 2.9% recorded is up from 2.2%, which might indicate that the bank anticipates more loan defaults and an increase in non-performing loans.


Non-Performing Loans as a % Total Loans 4.5% 4.2%

This ratio gives an indication of the trend, whether upwards or downwards, on the amount of non-performing loans. In this example, the trend shown is upwards which may point to a deteriorating asset quality of the loan book. A ratio of in excess of 5% is deemed high.


Provision for Loan Losses as a % of Non-Performing Loans

65% 53.3%

This ratio assesses the degree to which non-performing loans are covered by the balance sheet provision for loan loss provisions. In this case, the result is 65% for 2012, slightly higher than 2011. Taking into account the other computed asset quality ratios, the resultant ratio may indicate that the bank requires a higher provision. As a general guide, this ratio should not fall below 70%.

210.15: Asset quality ratio analysis

Earnings and Profitability


Net Interest Income as % of Interest Income 34% 35.5%

This ratio reflects the Interest Income level for the year before the addition to LLP against the loan book. The 2012 result shows a deterioration year on year of 1.5%. A ratio of 30% or above represents a very high profitability ratio.


Net Interest Income as a % of Total Assets 2.9% 3.4%

This ratio computes the net interest margin compared with total assets. The higher the ratio, the better margin or spread that the bank is able to achieve - being the difference between interest income on loans and other earning assets, less cost of funds on sources of funds and liabilities. A ratio of more than 2% is considered to reflect a good performance.


Total Other Income divided by Total Operating Income

16.7% 9.1%


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This ratio seeks to determine the relative importance of non-interest income as a proportion of total operating income. A high ratio when compared with a peer group and the overall sector may indicate that the bank relies heavily on securing fees and commission income from its product and service portfolio. This argument holds true to the extent that the net interest income margin also remains at or above the sector average.


Total Operating Income as a % of Total Assets 3.5% 3.7%

This ratio is similar to ratio number 2, but moves down the income statement and compares Total Operating Income to Total Assets.


Income before Tax as a % of Shareholder Funds

10.1% 10.2%

This ratio provides a measure of the return on shareholder funds at the pre-tax level. A ratio of 10% or above is rated as a good performance.


Income before Tax Total Assets 0.9% 1.0%

A complementary earnings ratio.


Total OPEX Costs as a % of Total Operating Income

53.9% 56.8%

Referred to as the Cost to Income ratio, this is a key measure used by analysts and rating agencies to determine how efficient a bank is relative to a peer group or the sector as a whole. A ratio of 50% or less is rated as a good performance, while a result in excess of 60% is an indicator of an inefficient bank. This is a simplistic assessment, and an analyst would need to drill down into detail to understand the specific circumstance of a bank. For example, a bank may have invested heavily in developing a branch network, which may have the effect of raising the cost to income ratio in the year when the investment was made, leading to one-off higher annual costs.


Addition to Loan Loss Provision (Income Statement) as a % of Total Loans

1.1% 1%

This measure was computed as one of the asset quality ratios. The ratio also can be used to understand and interpret the earnings of a bank.

210.16: Earning and profitability ratio analysis


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Liquidity Ratios

There are seven main liquidity ratios.


Cash Assets as a % of Total Deposits (including from Financial Institutions)

10.8% 17.6%

An indication of how liquid the asset side of the balance sheet is. A ratio of 10% or higher is deemed adequate, while a ratio of less than 10% may indicate that the bank’s asset base is becoming illiquid.


Loans as a % of Deposits 74.9% 82.4%

This ratio is a classic measure for a retail bank. In broad terms, customer deposits should be used to fund customer loans. In this case, a ratio up to 100% is deemed reasonable. A ratio greater than 110% indicates that a bank may be taking a riskier and aggressive approach to growing the loan portfolio and without an adequate and stable deposit base to fund the expansion. This may give rise to liquidity issues under stressed market conditions in particular where a bank experiences significant run-off by depositors.


Loans as a % of Assets 60.2% 58.9%

A ratio of up to 70% may be deemed appropriate for liquidity purposes. Ratios in excess of 70% may indicate that the loan book is expanding at a high rate and that available liquid assets are shrinking, leading to potential risk.


Liquid Assets (< 30 days) divided by Bank Total Liabilities

33.3% 32.6%

In this example, liquid assets are taken from the maturity analysis and for the total under one month. This ratio provides an approximate measure of the liquidity of a bank. It assumes that all of the assets with a maturity of less than 30 days can be converted into cash to meet immediate liquidity needs. A 33% result indicates a healthy liquidity position while a ratio of less than 20% is deemed high risk and illiquid.

Assets classified in less than 30 days are assumed to be very liquid. In reality and under stressed market conditions, the individual asset categories may not be as liquid as the classification suggests. A more detailed assessment should be made of each individual asset category and to drill down to determine whether the asset can be realised into a cash equivalent to provide immediate liquidity for a bank.


Liquid Assets (< 30 days) as a % of Customer Funding (Deposits)

37.6% 44.4%

This ratio focuses on liquid assets to the customer funding base (deposits). A ratio of 25% and above is deemed reasonable and liquid, while a figure less than 20% indicates an illiquid balance sheet position.


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Liquid Assets (< 30 days) as a % of Total Assets

30.3% 31.8%

A broad measure to indicate the overall liquidity of the total asset base. A ratio of less than 15% is deemed to indicate an illiquid balance sheet position.


Liquid Assets (< 30 days) as a % of Short- Term Liabilities (between 0-6 months)

53.8% 57.9%

This measure aims to show whether a bank has adequate liquidity to cover a potential run- off by depositors and other liability sources which are short-term in nature. It is therefore a narrower measure than No 5 above. A ratio of < 20% indicates an illiquid balance sheet position.

210.17: Liquidity ratios

The ratios set out above are in the nature of static measures, although computed and tracked over time to detect adverse or positive trends. Following the financial crisis of 2008 to 2009, the Basel Committee has reassessed the whole topic of liquidity risk management.

A key proposal made by Basel as part of the Basel III proposals on liquidity risk management, is for international banks to calculate and monitor on a regular basis a new ratio, termed the Liquidity Coverage Ratio (LCR) defined as:

Stock of high-quality liquid assetsNet Cash Outflows over a 30-day period > 100%

The LCR is intended to be a more dynamic and short-term ratio that measures the ability of a financial institution to survive a liquidity event or events resulting in a run-off in the depositor base. Banks are required to run various scenarios under different assumptions that would give rise to a significant outflow of funds, and to compare the forecast outflow with the ability to cover any liquidity gaps through the availability of high-quality liquid assets. The resulting ratio should exceed 100 percent. In the event that the ratio falls below 100 percent, a bank is required to adjust its asset and liability management approach to ensure that the bank is capable of withstanding a run on deposits and to move back to a position where the LCR exceeds 100 percent.

Many international banks are now computing the LCR and disclosing the results in their annual accounts. National regulators in the USA and European regulators will determine whether or not the LCR ratio will become mandatory for all financial institutions, or only for large internationally listed institutions. Basel III also introduced the net stable funding ratio (NSFR) which is fully discussed along with LCR in the Retail Banking II module Risk Management.

Drivers of Profitability

Drivers of bank profitability may be classified between two categories:

Financial drivers:

• Factors that influence a bank’s level of profitability such as growth

• Interest yield and achieved spreads

• Non-interest income

• Operating expense development

• Loan Loss Provision trend

• Components of a bank’s Return on Equity (ROE) a key measure for investors and analysts


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Other profitability drivers of a non-financial nature

• Relative success or otherwise of the bank’s stated business strategy

• The nature and range of the portfolio of products and services

• Sales and marketing channels

• Customer relationship management

The following financial measures are assessed in more detail:

• Net Interest Margin

• Returns on Earning Assets

• Cost of external funds

• The components of Return on Equity Capital

The first table below shows for a sample bank the relationship between earning assets of the bank and the returns made in the year. For 2012, the results disclose that the bank earned an overall rate of 13 percent on all earning assets compared to 11.2 percent in 2011. For greater accuracy, average balance sheet value is used. In practice, banks calculate daily, weekly and monthly average balance sheet values. However, the example provided illustrates the principles involved.

Earning Assets B/S (2012)

B/S (2011) B/S(2011)

Average Income (2012)

Income (2011)

% of Assets (2012)

% of Assets (2011)

Loans to Financial Institutions

400 300 350 7 6 2.0 1.7

Corporate Loans

700 600 650 70 60 10.8 9.2

Retail Loans 1,042 800 921 173 149 18.8 16.2

Total 2,142 1,700 1,921 250 215 13.0 11.2

210.18: Relationship between earning assets and returns

The second table below focuses on the liability side of the balance sheet and relates sources of funds and liabilities to the cost of those funds. The same principles have been used as for interest income on earning assets. The results disclose that the bank’s cost of funds on deposits was 7.5 percent for 2012 and 6.6 percent for 2011. Calculations are based on the Average Balance Sheet values.

Cost of all funds B.Sheet 2012

B.Sheet 2011

Av 11/12

IntExp 2012

IntExp 2011

% 2012

% 2011

Deposits by Central Bank 150 250 200 5 6 2.5 3.0

Deposits by Financial Institutions 175 250 213 4 4 3.3 1.9

Deposits by Customers:

Corporate 800 550 675 28 15 4.1 2.2

Retail 1,350 900 1,125 128 120 11.4 10.7

Total 2,475 1,950 2,213 165 145 7.5 6.6

210.19: Cost of funds analysis

The following table summarises the results and calculates the bank’s overall Net Yield or Spread. For 2012, the net yield was 5.5 percent, and 4.6 percent for 2011. The results should be compared and analysed against prior year results, budgets and forecasts and against the wider bank sector.


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Net Yield or Spread 2012 2011

Gross Yield on Earning assets 13 11.2

Cost of funds on Liabilities 7.5 6.6

Net Yield or Spread 5.5 4.6

210.20: Net yield analysis

The results of such analysis are driven by many factors including those set out below.

Approach taken to Asset Management • Structure of the asset side

• Maturity analysis (short -v- long term)

• Loan portfolio approach and growth

Approach taken to Liability Management • Funding strategy (sources and types)

• Maturity analysis (short versus long)

Liquidity position • Non-liquid assets versus liquid assets

• Less liquid assets have higher profit potential

External environment and market • Movement in market interest rates, including government set base rates

210.21: Analysis results

A further analysis can be made to analyse the net interest income between price and volume measures. The following table shows the basis of the calculation. The price effects in terms of movement in rates are isolated and calculated separately from balance sheet volume changes.

Current Year Prior Year Average

Assets 2,142 1,700 1,921

Income 250 215 233

% Yield 11.7% 12.6% 12.1%

1,700 x 12.6% 215

Less: Interest rate reduction of 0.9% (1,700 x 0.9%)

(17)

Volume change in assets (2,142-1,700) x 11.7%

52

Interest Income – Current Year 250

210.22: Analysis of net interest income

The analysis discloses a net reduction in the yield of 0.95 percent resulting in a nominal loss in income of 17. This was offset by growth on the asset side of the balance sheet resulting in additional income of 52.

Return on Equity (ROE)

Return on Equity Capital is a key performance indicator of profitability for shareholders and is


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reported on and discussed when banks publish periodic financial statements. There are many factors that influence the actual reported ROE, for example:

• Macro economic factors

• Market conditions

• Banks’ business and growth strategies

• Capital structure

• Asset structure (maturity analysis)

• Funding strategy and structure (maturity analysis)

• Liquidity management and strategy

• Risk preferences of management

• Efficiency (cost to income ratio)

There are three drivers for the ROE figure for our sample bank. These are shown in the table below. By multiplying the three ratios, the Return on Equity of 10 percent for 2012 is proven. Management can focus on optimising each indicator with a view to achieving the desired ROE figure. The ratios given below are for the bank in total. It is possible to break down the ROE into separate business units to determine the relative contributions of each business to the bank’s total ROE.

2012 2011

1. Gross Yield on Assets: Operating Income/ Total Assets 0.035 0.037

2. Net Profit Margin: Net Income/Operating Income 0.265 0.215

3. Leverage = Total Assets/ Total Equity 10.8 10.6

ROE = (1) x (2) x (3) 10.0% 8.4%

210.23: Analysis of return on equity

The above analysis focuses on the financial aspects of the ROE. There are many other inter-related factors that drive bank profitability. The following list is not exhaustive. Reference is made to other modules of the RBA programme, where the importance of some of these factors is expanded on in more detail. They include:

• Macro economic factors

• Movement in base rates set by governments

• Competition

• Banks’ business and financial strategies

• Organic growth versus acquisitions

• Banks’ balance sheet management strategy and effectiveness:

•Assetandliabilitystructureandmanagement

•Fundingstrategy

•Levelofrisk-taking


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•Capitaladequacylevels

•Effectivenessofriskmanagement

•Relativeimportanceandcontributionofthebankingbookversustradingbook

• Other factors which will drive profitability:

• Strategy and effectiveness of selected sales and marketing channels

•Branch network

•Remote branches

•Internet banking

• Customer relationship management

•Service levels and retention rates

•Net Promoter Score

• Analysing and understanding customer profitability and targeting profitable customers to increase returns:

•Corporate customers (by segment, public/private/SME)

•Retail, by products and services and customer segments

•Promoting services to profitable customer segments

• Flexible and targeted pricing for products and services (interest and fees)

• Cost efficiency in terms of managing downwards the cost to income ratio

SummaryThe scope of this module covered five areas: key principles of bank financial statements; structure of bank financial statements; analysis of bank financial statements using the CAMELS framework (Capital, Asset Quality, Management, Earnings and Profitability, Liquidity and Market Sensitivities; and drivers of bank profitability and the importance and relevance of bank capital.

While some financial analysis was conducted at a higher level in Retail Banking Overview, a more detailed financial statement analysis was conducted in this module with the familiar CAMELS approach as a guideline. This led to a discussion of maturity (gap) analysis; capital adequacy; liquidity ratios; profitability ratios; soundness of balance sheet with reference to non-performing loans; and impairment charges. The module concluded with a case study requiring a complete financial statement analysis.


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Case Study The following information is provided in respect of Standard Bank for the years ending 2011 and 2012.

• Income Statement

• Balance Sheet

• Loan Book Analysis

• Maturity Analysis


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Standard Bank Income Statement

2012 2011 ChangeIncome Statement US$m US$m US$m Interest Income 2,225 1,900 17.1%Interest Expense 1,615 1,525 5.9%NII 610 375 62.7%NII Margin % 27% 20% 38.9% Provision for loan impairment 75 45 66.7%% of interest income

3.4% 2% 42.3%

NII after Impairment provision 535 330 62.1%NNI after impairment provision as a % of Interest Income

24.0% 17.4%

Fees & Commission Income 110 61 80.3%Net Gain/(Loss) on sale of securities 15 12 25.0%Net Gain/(Loss) on sale of FI 12 6 100.0%FX Gains/(Losses) -22 2 -1200.0%Other Operating Income 12 11 9.1%Total Non-Interest Income 127 92 38.0% Total Operating Income 662 422 56.9% Non Interest Expense Payroll Costs 165 135 22.2%Admin & General 120 95 26.3%Depreciation 11 10 10.0%Fees & Commission 43 37 16.2%State Deposit Insurance 20 15 33.3%Other Operating Expense 35 29 20.7%Total Non Interest Expense 394 321 22.7%% of NII (Total Operating Expense/ Net Interest Income)

65% 86% -24.5%

% of NII after provision (Total Operating Expense/Net Interest Expense after Provision)

74% 97% -24.3%

Income Before Taxation 268 101 165.3%% of NII after Provision

50% 31% 63.7%

Taxation 73 17 329.4%% of Income before Taxation 27% 17% 61.8%Net Income after Tax 195 84 132.1%% of NII after Provision

36% 25% 43.2%


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Standard Bank Balance Sheet

2012 2011 % change US$m US$m Assets Cash and Central Bank 900 1,100 -18%Due from FI 350 220 59%Trading Portfolio 250 90 178%Available for sale securities 290 110 164%Loans to FI 600 700 -14%Loans to Customers(Net)

Corporate 7,000 5,100 37% Retail 9,270 6,200 50%Property and Equipment 750 575 30%Other assets 150 125 20% Total assets 19,560 14,220 38% Liabilities Deposits by Central Bank 800 700 14%Deposits by FI 2,200 1,600 38%Customer Deposits Corporate 5,800 4,300 35% Retail 8,700 6,300 38%Debt Securities 1,200 700 71%Other Liabilities 150 130 15%Total Liabilities 18,850 13,730 37% Shareholders Equity Share Capital 250 250 0%Revaluation Reserve 40 15 167%Retained Earnings 420 225 87%Total SH Equity 710 490 45%

Total Liabilities + SH Equity 19,560 14,220 38%


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Standard Bank Supplementary Data (Loans)

2012 2011 % change $m $m Loans Gross Corporate Loans 7,500 5,400 39%Less: Provision 500 300 67%Net Loans 7,000 5,100 37% Retail Loans (Gross) Consumer Loans 1,400 1,050 33%Auto Loans 3,200 2,450 31%Mortgages 4,300 2,550 69%Other loans 800 440 82%Sub-Total (Gross) 9,700 6,490 49%Provision 430 290 48%Net Retail Loans 9,270 6,200 50% 0 0 Total 16,270 11,300 44%

Non Performing Loans 160 135 19%

Total Loans Gross 17,200 11,890 45%Total Deposits 16,700 12,200 37%

Total Loans Net 16,270 11,300 44%

2010 2009 % Change $000 $000 Consumer Loans – Gross Consumer Loans 1,400 1,050 33%Auto Loans 3,200 2,450 31%Mortgages 4,300 2,550 69%Other Loans 800 440 82%Total – Gross 9,700 6,490 49% Less: provision Consumer Loans 25 17 47%Auto Loans 175 110 59%Mortgages 190 130 46%Other Loans 40 33 21%Total 430 290 48% Consumer Loans (Net) Consumer Loans 1,375 1,033 33%Auto Loans 3,025 2,340 29%Mortgages 4,110 2,420 70%Other Loans 760 407 87%Total 9,270 6,200 50%


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Standard Bank Maturity Analysis US$m

2012 < 1 month

1-6 months

6 months -1 year

1-3 years

3-5 years

No Maturity

Total

Assets Cash and Central Bank 450 450 900Due from FI 150 175 25 350Trading Portfolio 250 250Available for sale securities 290 290Loans to FI 100 300 200 600Loans to Customers Corporate 500 900 3,200 2,400 7,000 Retail 750 1,600 2,900 4,020 0 9,270Property and Equipment 750 750Other assets 10 50 90 150Total Assets 2,500 3,475 6,325 6,420 0 840 19,560Liabilities Deposits by Central Bank 300 500 800Deposits by FI 1,500 700 2,200Customer Deposits Corporate 1,700 2,800 1,300 5,800 Retail 2,400 2,600 2,150 1,550 8,700Debt Securities 500 600 100 1,200Other Liabilities 50 50 50 150Total Liabilities 6,450 7,250 3,600 1,550 0 0 18,850

Mismatch -3,950 -3,775 2,725 4,870 0 840 710Cumulative -3,950 -7,725 -5,000 -130 -130 710

2011 < 1 month

1-6 months

6 months -1 year

1-3 years

3-5 years

No Maturity

Total

Assets Cash and Central Bank 600 500 1100Due from FI 100 120 220Trading Portfolio 90 90Available for sale securities 110 110Loans to FI 390 310 700Loans to Customers Corporate 350 1800 1700 1250 5100 Retail 550 1700 1800 2050 100 6200Property and Equipment 575 575Other assets 50 50 25 125Total Assets 2240 4480 3525 3300 100 575 14220Liabilities Deposits with Central Bank 350 350 700Deposits with FI 900 700 1600Customer Deposits Corporate 1200 1200 1300 600 4300 Retail 1300 1650 1100 2250 6300Debt Securities 400 150 150 700Other Liabilities 25 45 60 130Total Liabilities 4175 4095 2610 2850 0 0 13730Mismatch -1935 385 915 450 100 575 490Cumulative -1935 -1550 -635 -185 -85 490


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RETAIL BANKINGACADEMYCourse Code 210 - Financial Management

Multiple Choice Questions based on the Case Study

1. Which statement is correct?

a) The Leverage Ratio (Total Assets divided by Shareholder Equity) exceeds 33 in 2011.b) Provision for Loan Losses (Balance Sheet) as a proportion of the Loan Portfolio is 5.7 percent in 2012.c) Total Costs as a proportion of Total Operating Income is below 50 percent in 2011 and 2012.d) Loan to Deposit ratio exceeds 100 percent in 2012.

2. The following ratios are calculated for 2012:

Gross Yield on Assets = 3.4%Net Profit Margin = 29%Leverage Ratio = 27.5

The Return on Equity (ROE) for 2012 is:

a) 17.14%b) 13.20%c) 27.46%d) 14.32%

3. Which statement is incorrect?

a) The net interest income margin increased from 17.4 percent in 2011 to 24 percent in 2012.b) A comparison of the cost income ratio between the two years indicates an increase in efficiency.c) Fee and commission income rose 80 percent between 2011 and 2012.d) Net income after tax increased in 2012 marginally over 2011.

4. In comparing the loan book between 2011 and 2012, which statement is incorrect?

a) Non-performing loans grew at a lower rate than the rate of growth of the loan book.b) Non-performing loans as a proportion of total loans improved from 1.2 percent in 2011 to one percent in 2012.c) The balance sheet shows that net retail loans grew slower than net corporate loans. d) Loans to financial institutions fell 14 percent.

5. A consideration of the maturity analysis for 2012 will show which of the following to be incorrect?

a) The deposit base of the bank is mostly short term (less than 12 months).b) More than 40 percent of retail loans have a maturity that exceeds one year.c) There is the highest mismatch in the first six months. d) The maturity analysis for 2012 shows that liquidity problems are more likely in the long run.

6. When comparing the capital position of the bank between 2011 and 2012, which of the following statements is correct?

a) The capital adequacy ratio for 2012 is higher than the Basel III requirement of eight percent.b) The bank’s capital position in 2012 was enhanced by a substantial increase in retained earnings.c) The current capital position is consistent with a strategy for the bank to expand the loan book in the future.d) The bank is currently over-capitalised.

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7. The following statements summarise the bank’s financial condition in 2012 compared with 2011. Which is incorrect?

a) The bank will need to secure new capital or deleverage its balance sheet to restore its capital adequacy.b) Profitability as evidenced by ROE has improved in 2012 relative to 2011.c) The loan to deposit ratio increased by almost five percentage points in 2012 over 2011.d) Net interest income grew at a lower percentage rate than non-interest income.

8. Which statement is incorrect?

a) The bank’s liquid assets as a proportion of total assets have declined in 2012 relative to 2011.b) Liquid assets as a proportion of Short-term Liabilities (<6 months) have declined by about 33 percent. c) Liquid assets as a proportion of customer funding has increased in 2012 over 2011.d) Loan to asset ratio has increased in 2012 relative to 2011.

9. In relation to gross retail loans, which of the following has experienced the highest rate of growth in 2012 relative to 2011 and also has the highest share of the loan book in 2012?

a) Consumer loansb) Mortgages c) Auto loansd) Other loans

10. Which of the following statements (comparing financial performance in 2012 over 2011) is incorrect?

a) Total non-interest income grew at a faster rate than total non-interest expense.b) Fees and commission income grew at a faster rate than fees and commission expense.c) Net income after tax grew only marginally so that profitability experienced almost no growth.d) Total Operating Expense as a proportion of Total Interest Income has declined, indicating significant increases in efficiency.

Answers

1 2 3 4 5 6 7 8 9 10

b c d c d b d c b c


Rb ii new 210 small

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