Analysis of Financial Statement of Banks

Bankers are familiar with Profit & Loss Account and Balance Sheet of Corporates as they day in and day out read, analyze, disseminate information for processing the credit requirements of the borrowers. They calculate various ratios including Current Ratio, Interest Coverage Ratio, Debt Equity Ratio, Debt Service Coverage Ratio to assess whether the Bank will be assured of return of its funds. They flip through hard bound books of Reports submitted by them in order to be doubly sure that they are financing the right borrower with eligible financial limits.

But, we hardly come across any banker reading the financial statements of his own Bank.

While preparing financial statements, banks have to follow various guidelines / directions given by RBI/Government of India governing the Financial Statements. It is important to go through the Director’s Report, Management Discussion and Analysis Report, Corporate Governance Certificate which normally precede the Financial Statements. All together all these are incorporated in Annual Report of the Bank.

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HIGHLIGHTS OF BANKS’ BALANCE SHEETS :

The following are the highlights of Banks’ Balance Sheets :

1. Balance Sheet is prepared in conformity with Form A of the Third Schedule to the Banking Regulation Act, 1949 and Profit and Loss Account in conformity with Form B ibid. They are prepared in accordance with provisions of Section 29 of the Banking Regulation Act read with Section 211 (10), (2), and 3 © of the Companies Act 1956.


2. They are always prepared as on 31st March of every year. Listed Banks are required to publish Review financial results every quarter. But full fledged Profit and Loss Account and Balance Sheet are prepared as on 31st March every year by all the Banks.


3. They contain 18 schedules as under :

Schedules forming part of Form A – Balance Sheet
Schedule - 1 - Capital

Schedule - 2 - Reserves & Surplus

Schedule - 3 - Deposits

Schedule - 4 - Borrowings

Schedule - 5 - Other Liabilities and Provisions

Schedule - 6 - Cash and balances with RBI

Schedule - 7 - Balances with Banks and money at call and short notice.

Schedule - 8 - Investments

Schedule - 9 - Advances.

Schedule - 10 - Fixed Assets.

Schedule - 11 - Other Assets.

Schedule - 12 - Contingent Liabilities / Bills for Collection.

Schedules forming Part of Form B – Profit and Loss Account
Schedule - 13 - Interest Earned.

Schedule - 14 - Other Income.

Schedule - 15 - Interest Expended.

Schedule - 16 - Operating Expenses.

Schedules forming Part of Annual Report
Schedule - 17 - Significant Accounting Policies.

Schedule - 18 - Notes forming part of accounts.

Some of these Schedules viz., 1,2,4,8,17 and 18 are not required to be prepared by Bank’s branches. They are consolidated at Head office level. Schedule 1 to 5 form Liability Side of the Banks Balance Sheet and Schedule 6 to 12 on the Asset side of the Balance Sheet. The Assets side of the Balance Sheet has been arranged in such a manner that liquid assets such as Cash, Balances with Banks and Investments are shown in that order. This enables the investor to quickly identify how much the Bank is liquid enough to meet its commitment towards its customers. This arrangement of Assets is from liquid to fixed assets in contrast to corporate balance sheets where the arrangement is from fixed to liquid.

1. RBI mandated all banks to disclose the accounting policies regarding key areas of operation in Schedule 17 alongwith Note to Accounts in their financial statements. They include basis of Accounting, Transactions involving Foreign Exchange, Investments etc.


2. RBI has also directed Banks to make 53 disclosures to enable the market participants to assess the key areas of performance of the Banks. In addition to 53 disclosures mandated by RBI, Banks are also required to comply with the Accounting Standard 1 (AS 1) on Disclosure of Accounting Policies issued by Institute of Chartered Accountants of India.


3. The performance of Bank is assessed through calculation of various ratios such as CRAR, Gross NPA, Net NPA, NIM, Interest income as percentage to average working funds, Non interest income as percentage to average working funds, Operating profit as percentage to average working funds, Return on Assets, Business / Profit per employee, Provision Coverage Ratio, etc. whereas a Company’s strength is assessed through Current Ratio, ISCR, DER, DSCR etc.


4. Banks prepare two sets of financial statements (includes Balance Sheet and Profit and Loss Account), one containing the performance of the Bank through its Banking operations, both domestic and international and the other called consolidated Financial Statements containing the performance of the Bank of its Banking operations and subsidiary units, joint ventures and associates in accordance with AS 21, issued by ICAI on a line-by-line basis by adding together the like items of assets, liabilities, income and expenditure of the Bank. Sometimes, a standalone balance sheet may give a better picture of performance of the Bank than when consolidated business of the subsidiaries, joint ventures and associates are combined, if they have less profit making subsidiaries. Investor is interested in consolidated financial statements as it is the position of the “Group”. Some banks having international branches may prepare financial statements in dollar terms also to meet the requirements of their overseas centres.


5. They are prepared on the basis of “going concern approach” adhering to various accounting, disclosures prescribed by agencies like ICAI (Accounting Standards – GAAP), RBI (Banking Regulation Act, RBI Act), and Government of India. Banks are also required to prepare their financial statements based on International Financial Reporting Standards wef. 1.4.2013.

Now look at the Schedules forming part of Financial Statements :

SCHEDULE 1 : CAPITAL & LIABILITIES :
The Schedule gives details of Authorised, Issued, Subscribed and Paid up Capital of the Bank. Special mention should be made of capital held by Central Government. If calculated in percentage terms, it will give an idea of Central Government’s contribution to the Capital of the bank. For example, as on 31.3.2012, Oriental Bank of Commerce’s paid up capital was Rs.291.76 Cr out of which Central Government holding was Rs. 169.22 Cr representing 57.99 %. In the case of Bank of India, the paid up capital was Rs. 574.51 Cr out of which Central Government holding was Rs.359.88 Cr. representing 62.72 % . Investor can get an idea which bank’s share has velocity in the market and better traded.

SCHEDULE 2 – RESERVES & SURPLUS:
This schedule consists of Statutory Reserves, Capital Reserves (revaluation reserve), Share Premium, Revenue & Other Reserves.

Statutory Reserve is created by transferring 25 % of net profit earned by the Bank every year.

Capital Reserve consists of revaluation reserve created out of (1) revaluation of property of the Bank , (2) Profit on sale of investments, which are “Held to Maturity” (3) Foreign Currency Translation Reserve and (4) Special Reserve for Currency Swaps. These items of capital reserve are appropriated from Net Profit of the Bank.

Share Premium is created from the premium collected by the Bank while issuing shares to the public.

Revenue & other reserves are recreated by transferring balance of Net profit after making appropriations for Statutory, Capital Reserves, Dividend payment and Special Reserves.

SCHEDULE - 3 - DEPOSITS:
Deposits are mainly bifurcated into Demand Deposits (which includes Current Account Deposits, Sundry Deposits and Overdue Term / Time deposits), Savings Bank Deposits and Term Deposits. Sub-bifurcation in all these segments is Deposits from Banks and Others. It is now established that a bank should have higher percentage of Demand Deposits and Savings Bank Deposits (CASA Deposits) for better NIM (net interest margin). In the computerized environment, Branches should not have major chunk of Overdue Term Deposits in the Demand Deposits portfolio. It will also have an impact on the Assets and Liabilities Management of the Bank (ALM). As per the recent guidelines of Government of India, bulk deposits should not be more than 10 % of the total deposits.

SCHEDULE – 4 – BORROWINGS :
This schedule which is managed at Head Office level, consists of borrowing from RBI and other Banks. Borrowings from other Banks/other Institutions are mainly funds raised under various instruments (Innovative Perpetual Debt Instruments, Subordinated debts, Unsecured non convertible redeemable bonds etc) which qualify for Tier I and II capital of the Bank.

Schedules 1 (Capital), Schedule 2 (Reserves & Surplus) and Schedule 4 (Borrowings) are relevant for calculation of Capital to Risk Weighted Asset Ratio (CRAR) as some balances under these schedules are considered for Calculation of CRAR.

Some important points to be noted here for calculation of Capital Adequacy under Basel I and II guidelines are given below : (Basel III guidelines are still in discussion stage and hence are not considered here)

1. Banks are required to maintain minimum capital of 9% on on-going basis for Credit Risk, Market Risk and Operational Risk.


2. The capital so calculated consists of Tier I and Tier II capital.


3. Minimum Tier I capital should be 6%


4. 80% of minimum capital to be maintained under Basel I frame work.


5. Banks are required to declare the CRAR under Basel I and II frame works in their financial statements.


6. Method of computing risk weights is different under Basel I and Basel II frame works.

SCHEDULE 5 – OTHER LIABILITIES AND PROVISIONS:
The schedule mainly consists of Bills Payable (both inward and outward Bills for collection sent to upcountry banks/branches), Interest accrued, Contingent provisions against standard assets (banks are required to maintain provisions on Standard Assets @ 0.25 % to 0.40% and in some cases 1%), Proposed Dividend and any other liabilities that have to be provided for.

The above schedules 1 to 5 form Liabilities side of the Balance Sheet. The following schedules form part of Assets side of the Balance Sheet.

SCHEDULE 6 – CASH AND BALANCES WITH RBI :
Cash in Hand represents the cash held by branches of the Bank. All Branches are required to maintain cash within retention limit prescribed by the bank (normally 0.25% of deposits). Any amount beyond the limit should be transferred to RBI accounts so that the balances in RBI accounts qualify for CRR (Cash Reserve Ratio) calculations. Keeping excess cash is fraught with security issues, and the Bank will be losing interest / other benefits on idle component of the Cash held at branches.

Balances with RBI qualify for CRR calculations. Excess amount over required CRR will qualify for SLR (Statutory Liquidity Ratio).

Branches should therefore maintain minimum cash with them.

SCHEDULE – 7 – BALANCES WITH BANKS AND MONEY AT CALL AND SHORT NOTICE :
Balances with Banks represent the balances maintained by branches with other Banks (such as SBI) for clearing purposes, etc. Any excess balance should be transferred to RBI account. Balances with banks do not earn any interest and also under Basel I frame work, Banks are required to calculate Risk weights @ 20% of such balances.

Money at Call and Short Notice are entries created by Treasury of the Bank and hence should not reflect in individual branch balance sheets unless parked for any reason by the Bank.

SCHEDULE – 8 – INVESTMENTS:
Investments are bifurcated into six segments in Balance sheets, viz. i) Government Securities, ii) Other approved Securities, iii) Shares, iv) Debentures and Bonds, v) Subsidiaries / joint ventures, vi) Others

The Investments under Government Securities and Other Approved Securities qualify for SLR (Statutory Liquidity Ratio) calculations. Investments under Others include CDs/CPs etc.

All investments are to be classified into Held to Maturity, Held for Trading and Available for Sale. Depending upon the classification of the investments into these categories valuation of investments has to be made as per RBI guidelines. The valuations will have a great bearing on the profit of the bank.

SCHEDULE 9 – ADVANCES :
There are three classifications under Advances, viz. first classification into Bills purchased and discounted, Cash Credit, Overdrafts and Loans repayable on demand (normally loans with repayment period less than 36 months) and Term Loans. This classification will enable the investor to know the liquidity of funds for the Bank and also how the interest streams are ensured. For example, if the balances under Cash Credit, Overdraft etc are more than Term Loans, the Bank’s liquidity position is good where as more balances in Term Loans show steady profit by way of interest earnings.

Second classification is based on the security available in the loan portfolio. The classification is i) secured by tangible assets, ii) covered by Bank/Government Guarantee and iii) unsecured. Large amount of unsecured advances and / or increase over last may indicate the Bank’s vulnerability for credit risk.

Third classification is, Advances under i) Priority Sector ii) Public Sector iii) Banks iv) Others. This classification is required as all banks are required to lend 40 % of their Advances under Priority Sector.

As of now, capital requirement for Credit Risk is higher than Capital requirement for Market Risk and Operational Risk. It is therefore necessary that while undertaking Credit Risk availability and costs of additional Capital requirement need to be looked into. A realignment of portfolios and/ or securing assets with collaterals will enable reduce risk weights.

For example, under Basel I frame work, all outstanding advances carry a risk weight of 100%, whereas under Basel II frame work, the risk weights vary from 20 % to 150% depending upon corporate borrowers external rating, unsecured portfolios and similar activities.

Under Basel I frame work, cash margins and deposits are eligible financial collaterals. For example, a borrower has been financed Rs.100 lakhs and there is a deposit of Rs. 10 lakhs as cash collateral, for the purpose of calculation of risk weights, the amount is Rs. 90 lakhs. Under Basel II frame work, not only cash collaterals, bonds, gold, debt mutual funds etc. are also considered as collateral for calculation of risk weights.

Under Basel II frame work, risk weight for restructured advances is 125 % whereas under Basel I, it is 100%.

If branches are able to understand the concept of risk weights for credit risk, they can ensure and properly account for all eligible securities as collaterals for calculation of risk weights, thus reducing the higher requirement of Capital.

Further, the advances shown under this schedule are net of provisions. In other words, they only include performing portion of advances.

SCHEDULE 10 – FIXED ASSETS AND SCHEDULE – 11 OTHER ASSETS:
These schedules do not need much explanation. However, Branches are to be careful while calculating depreciation of these assets as it will have a direct bearing on the profit of the Bank. Many branches continue to hold unserviceable, irreparable furniture and redundant computer hardware items on their books. They should ensure to dispose of the same and properly account for only serviceable items.

SCHEDULE – 12 CONTINGENT LIABILITIES:
They mainly consists of Claims against the bank not acknowledge as debts, Liability on account of outstanding Forward Exchange Contracts, Derivative Contracts, Guarantees Issued etc.

Notes to accounts should be referred to for any disputed liabilities that are hampering the profit of the bank in case the contingent liabilities turn out to be funded liabilities.

At branches, bifurcation of guarantees into Financial and Performance should be done correctly as they carry different risk weights for CRAR calculation. Any cash collaterals available in the guarantees should be properly reduced from the outstanding amounts for CRAR calculations. The liability in respect of expired guarantees should be reversed immediately following the guidelines of their Banks.

SCHEDULE 13 – INTEREST EARNED,
SCHEDULE – 14 – OTHER INCOME,
SCHEDULE 15 – INTEREST EXPENDED AND
SCHEDULE 16 – OPERATING EXPENSES :
These schedules form FORM-B of Financial Statements. They are profit and loss statements of the Bank.

SCHEDULE – 17 SIGNIFICANT ACCOUNTING POLICIES :
This schedule discusses various accounting policies adopted by the Bank in preparing the financial statements. The schedule mainly should be looked into to check whether Bank has made any changes in the accounting procedures which may have bearing on the profit and loss of the Bank.

SCHEDULE 18 – NOTES FORMING PART OF THE FINANCIAL STATEMENTS :
RBI mandated all banks to make 53 specific disclosures in respect of preparation of financial statements. One must go through these disclosures to really understand the SWOT (STRENGTH, WEAKNESS, OPPORTUNITY, THREATS) of the Bank. Depending upon the market analysis and requirements, RBI advises the Banks to make more disclosures in their Financial Statements.

This schedule forms crux of the strength of the Financial statements. Financial Statements reflect outstanding balances in the books of the Bank on a given date. This schedule disseminates important information about the balances reflected in each schedule.

CONCLUSION :
All stake holders (investors, customers, depositors, staff and Government, RBI and others) should go through all the schedules to effectively know the strength of a Bank. Employees should understand how schedules are prepared so that by realignment of some of the balances their Bank can reflect a good CRAR.