Financial Statements of a Bank

By Ashra Rehmat

Introduction

Financial statements for banks present a different analytical problem than statements for manufacturing and service companies. As a result, analysis of a bank's financial statements requires a distinct approach that recognizes a bank's unique risks.

• As financial intermediaries, banks assume two primary types of risk as they manage the flow of money through their business.

• Interest rate risk• Credit risk

Introduction to Balance Sheets and Income Statements

The balance sheet summarizes the financial position of an organization at a given moment, it is a snapshot of the firm.

The balance sheet reflects the status of the organization’s assets, (the economic resources owned by the organization), liabilities (debts owned to creditors), and equity (the owner’s investment in the organization).

Balance Sheet

As its name implies the balance sheet should indicate that these elements are in balance.

Assets = Liabilities + Equity This fundamental relationship must always

exist, because the assets represent the things owned by the organization and the liabilities and equity indicate how much was supplied by both creditors and owners.

The Bank Balance Sheet

• A bank’s balance sheet lists sources of bank funds (liabilities) and uses to which they are put (assets)

• Banks invest these liabilities (sources) into assets (uses) in order to create value for their capital providers

Income Statement

In contrast to the balance sheet, the income statement shows the organization's financial progress over a given period of time. The income statement is also based on equation:

Revenues - Expenses = Profit (or Loss)

Balance SheetAssets Liabilities & Equity

Deposits

Equity

Cash

Securities

Loans

Other Assets

Other Borrowings

Other Liabilities

The Bank Balance Sheet

Pay no interest

Secondary reserves

74% of Assets

Lowest cost source of funds--payable on demand

Deposit with no check writing

Discount loansFed Funds,

Corporate Loans have grown by factor of 10 since 1960 as % of Liab

Bank Equity = Assets - Liabilities, listed as Liab because Bank owes this to owners. Also includes Loan Loss Reserves

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Point of View: Bank vs. Customer

• Customers hear bankers say, “The bank will credit your deposit account.”

• Customers view their deposits as assets.• Therefore, customers think credits = assets.

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Off Balance Sheet

• What does “off balance sheet” mean?• Why do off balance sheet items exist?• Why aren’t they on the balance sheet?

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Off Balance Sheet

• Off balance sheet items:– Things that a business has possession of (or

responsibility for) but does not actually own– Commitments that a business has made but is

not yet scheduled to fulfill– Obligations a business has committed to

depending on the outcome of contingent events

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Balance Sheet

Debits Credits

Assets Liabilities & Equity

At any point in time,balance sheet debits

=balance sheet credits

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Income Statement

Debits Credits

Financial Events

Over any period of time,all debits

=all credits

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Income Statement

CostItems

RevenueItems

Expense Income

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Income Statement

CostItems

RevenueItems

Expense Income

Profit

Increase in equity

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Income Statement

CostItems

RevenueItems

Expense Income

To balance sheet

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Income Statement

CostItems

RevenueItems

Expense Income

Increase in asset value Increase in equity

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Income Statement

CostItems

RevenueItems

Expense Income

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Income Statement

CostItems

RevenueItems

Expense Income

Loss

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Income Statement

CostItems

RevenueItems

Expense Income

Decrease in asset value

Decrease in equity

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Cash Flow — Sources and Uses

• Typical sources of cash:– Sales– Decreases in assets– Increases in liabilities– Increases in capital accounts– Non-cash expenses

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Cash Flow — Sources and Uses

• Typical uses of cash:– Expenses– Increases in assets– Decreases in liabilities– Decreases in capital accounts

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