What do banks do? • Facilitate the flow of funds from savers to borrowers How are banks different? • Regulated • Few fixed assets • Few fixed costs • Less equity, more debt • Several liabilities are payable on demand or carry short-term maturities • Credit default and interest rate risks Balance Sheet Capital and liabilities • Equity or preferred capital • Reserves and surplus • Deposits • Demand deposits • Savings bank deposits • Term deposits • Borrowings • From the Reserve Bank of India (RBI) • From others • Other liabilities Assets • Cash and balances • Cash in hand • Balances with RBI • Balances with banks • Investments • Government securities • Shares • Debentures • Advances • Short-term • Long-term • Fixed assets • Other assets Income Statement Income • Interest earned • Advances • Investments • Balances with RBI and others • Other income • Commission, exchange and brokerage • Profit/loss on sale of investments/assets • Interest and dividend income Expenses • Interest expended • Deposits • RBI • Inter-bank borrowings • Operating expenses • Provisions for loan losses • Income taxes Financial analysis Income statement: Burden and efficiency • Interest income (II) • Other income (OI) • Interest expended (IE) • Operating expenses (OE) • Provisions for loan losses (PL) • Income taxes (IT)
Net interest income (NII) = Interest income (II) –
Interest expended (IE) Interest income • Rate • Duration of loan • Creditworthiness of borrowers • Type of industry • Volume • Earning assets/TA (EA/TA) • Composition of earnings assets Other income • Type • Fee • Commission • Profit/loss on sale of investments, etc. • Frequency • Recurring • Non-recurring Interest expended • Rate • Duration of deposits • Own risk • Market interest rates • Volume • Interest-bearing liabilities/TA (IBL/TA) • Composition of interest-bearing liabilities Operating expenses • Salaries • Rent • Other overheads Ratios Efficiency • Net Interest Margin = NII/EA • Spread = II/EA – IE/IBL • Burden ratio = (OE – OI)/TA • Efficiency ratio = OE/(NII + OI) Risk • Leverage ratio = TA/Shareholders’ Equity (TA/SE) • Loan ratio = Total loans/TA (TL/TA) • Provision for loss ratio = PL/TL • Loss ratio = Loan losses/TL • Non-deposit borrowings ratio = Non-deposit borrowings/Total assets • Capital adequacy ratio = Capital/Risk weighted assets Liquidity • Demand-to-time deposits ratio = Demand deposits/Time deposits • Cash-to-demand deposits ratio = Cash and bank balances/Demand deposits • Cash ratio = Cash/TA DuPont analysis Return on Equity (ROE) = Net Income/Shareholders’ Equity ROE = NI/SE
ROE = Net Income * Average Total Assets
Average Total Assets Average Total Equity
ROE = ROA * Leverage
DuPont analysis
ROE = NI/(II+OI) * (II+OI)/TA * TA/SE
DuPont analysis Net Income (NI) = II+OI-IE-OE-PL-IT