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(Three) The Financial Statements of

CHAPTER FIVE

Banks and Their Principal Competitors

The purpose of this chapter is to acquaint the students with the content, structure and purpose of bank financial statements and to help managers understand how information from bank financial statements can be used as tools to reveal how well their banks are performing.
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Bank Financial Statements Reflect services offered Overall size

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Analysis of performance Important Financial Statements Report of Condition Balance Sheet Report of Income Income Statement Sources and Uses of Funds Statement Statement of Stockholders Equity
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Report of Condition
The Balance Sheet of a Bank Showing its Assets, Liabilities and Net Worth
Accounting Equation: Assets=Liabilities +Equity Capital (1)

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Assets= Resources with future benefits that are owned and controlled by a company Examples: cash, supplies, equipment and land Liabilities= What a company owes to its nonowners (creditors) Examples: debt to a bank in the form of a note payable, accounts payable to supplies Equity= owners claim on assets (Owners equity) Accounting System: What a company owns and what it owes
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C + S + L + MA = D + NDB + EC Accumulated uses of bank funds= Accumulated sources of bank funds

(2)

(3)

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C + S + L + MA = D + NDB + EC

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= Cash Assets

S = Security Holdings L = Loans MA = Miscellaneous Assets

D = Deposits NDB = Nondeposit Borrowings EC = Equity Capital

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Cash Assets (C)

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Account is Called Cash and Deposits Due from Bank Includes:

Vault Cash Deposits with Other Banks Cash Items in Process of Collection(uncollected checks) Reserve Account with the Federal Reserve/BB
Objective is to keep the size of this account as small as possible as they earn little or no interest income

Sometimes Called Primary Reserves

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Security Holdings (S)

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Money Market Securities Secondary Reserves:short-term govt. securities, interestbearing time deposit held with other banks etc. Investment Securities
Taxable Securities: Govt. or corporate bonds and notes Nontaxable Securities: tax-exempt bonds and notes >>>Recorded in the BS at lower of cost or market

Trading Account Securities


>Held for Resale Only >Valued at Market Value

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Loan Accounts

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Loans Sum of All Loans Allowance for Possible Loan Losses


Gross

Contra Asset Account For Potential Future Loan Losses

Net

Loans Nonperforming Loans: Due more than


90 days
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Miscellaneous Assets
Fed

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Funds Sold: Reserve sold Securities Purchased Under Agreement to Resell (Repurchase Agreements) Customers Liabilities on Acceptances Net Premises and Equipment Other Miscellaneous Assets: Goodwill
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Deposit Accounts

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Non interest-Bearing Demand Deposits Savings Deposits: Bear the lowest rate of interest Money Market Deposit Accounts (MMDA): >limited check>interest>notice for withdrawal Time Deposits (Certificate of Deposits [CDs]) >fixed maturity>higher interest rates>

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Nondeposit Borrowings
Fed

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Funds Purchased: Reserve loaned to it by other banks Securities Sold Under Agreement to Repurchase (Repurchase Agreements)

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Equity Capital (EC) Preferred Stock Common Stock

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Common Stock Outstanding Capital Surplus Retained Earnings (Undivided Profits) Treasury Stock (Retired stock) Contingency Reserve (Unforeseen losses)

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Composition of Bank Balance Statements


(Percentage Mix of Bank Sources and Uses of Funds)

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Banks Bank < Between $100 Million $100 Mill. All Banks % % $1 Bill. % Cash and Deposits Due from Banks 5.95 5.72 4.64 Investment Securities 17.96 24.00 22.65 Fed Funds Sold and Repos. 4.84 5.60 3.57 Total Loans and Leases (Net) 58.20 60.22 64.04 Commercial and Industrial 25.20 17.18 17.76 Consumer 16.19 12.44 10.95 Real Estate 46.26 58.64 66.10 To Depository Institutions 3.01 0.00 0.28 To Foreign Governments 0.19 0.00 0.12 Agriculture 1.23 10.32 2.96 Other Loans 3.56 1.03 1.12 Leases 4.36 0.39 0.71 Assets Held in Trading Accounts 4.62 0.00 0.00 Bank Premises and FA (Net) 1.17 1.88 1.81 Other Assets 7.26 2.58 3.29 Total Assets 100.00 100.00 100.00 Interest Bearing Deposits 53.55 71.69 68.77 Noninterest Bearing Deposits 13.30 13.00 12.80 Fed Funds Purchased and Repos. 7.66 0.91 2.70 Other Liabilities 16.40 3.50 6.05 Total Equity Capital 9.09 10.90 9.68 Total Liabilities and Equity 100.00 100.00 100.00

Banks > $1 Billion % 6.16 17.02 4.99 57.25 26.77 17.21 42.47 3.58 0.23 0.56 4.05 5.13 5.48 1.04 8.06 100.00 50.57 13.34 8.66 18.44 8.94 100.00

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Off-Balance-Sheet Items
Fee generating services not fully disclosed in the balance sheet: Unused Commitments: Bank received a fee to lend up to a certain amount Standby Credit Agreements: Bank promises to guarantee repayment of a customers loan taken from a third party Derivative Contracts: financial institution has the possibility to incur profit or loss

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Make the bank more risky than appeared in the financial statements
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Report of Income

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The Statement of Revenues, Expenses and Profits for a Bank

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Net Interest Income = Interest Income Interest Expenses


Interest Income

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Interest Expenses

Interest and Fees on Loans Taxable Securities Revenue Tax-Exempt Securities Revenue Other Interest Income

Deposit Interest Costs Interest on Short-Term Debt Interest on Long-Term Debt

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Net Noninterest Income = Noninterest Income Noninterest Expenses

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Noninterest Income

Noninterest Expenses

Service Charges on Customers Deposits Trust Department Income Other Operating Income

Wages and Salaries Other Personnel Expenses Net Occupancy Expenses Other Operating Expenses

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Income Statement

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Net Interest Income -Provision for Loan Loss Net Income After PLL +/- Net Noninterest Income Net Operating Income +/- Security Gain (loss) Net Income Before Taxes -Taxes Net Income -Dividends Undivided Profits
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XXXXX XXXXX XXXXX XXXXX XXXXX XXXXX XXXXX XXXXX XXXXX XXXXX XXXXX

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Provisions for Possible Loan Loss (PLL)


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Experience Method Specific Charge-Off Method

Example: Suppose a bank anticipated loan losses this year of $10,000 and held $100 thousand already in the ALL account.
Beg. Bal. Allowance for Loan Losses (ALL) + This years Provision for Loan losses (PLL) Adjusted Allowance for Loan Losses (ALL) -Actual Charge-offs for worthless loans Net Allowance for Loan Losses = = = = = $ 100,000 $ 10,000 $110,000 $ 5000 $105,000

+Recoveries from Previously Charged-off Loans =


End. Bal. in the Allow. for Loan Loss Ac.(ALL) =
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$ 3,000
$108,000

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Statement of Stockholders Equity

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Report Showing the Changes in the Make Up of the Banks Capital Account

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Statement of Stockholders Equity

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Beginning Capital Account Balance +/- Net Income for Period - Preferred Stock Dividends - Common Stock Dividends + New Shares of Stock Issued - Purchases of Treasury Stock Ending Capital Account Balance
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Sources and Uses of Funds Statement


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Also Known as the Funds-Flows Statement It asks Two Questions Where Do Funds Come From? How Were Those Funds Utilized?

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Sources and Uses of Funds

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Sources

Uses

Net Income Noncash Expenses Decrease in Assets Increase in Liabilities Increase in Capital Accounts

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Net Loss Dividends Increase in Assets Decrease in Liabilities Decrease in Capital Accounts

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Financial Statements of Bangladeshi Banks

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Bank Companies Act, 1991 Section 38 Format of Financial Statements

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The Financial Statements of Nonbank Financial Firms

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The financial statements of other financial institutions, in recent years, come closer to bank statements

Finance Company:
USE: Loan> Receivables: BS is dominated by loans> Called Accounts Receivable>Business receivables, consumer receivables, real estate receivables> reflecting loans made to these customers SOURCE: Deposit>Borrowings: Borrowings from the money market>Borrowings from banks etc.
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Life/Property Insurance Company: USE:Loan> Loans to the business sector Holding of bonds, stocks and mortgages SOURCE: Deposit>Premium

Premium payment, Borrowings in the money and capital markets


Mutual Funds: USE:Loan> Corporate stocks, bonds, asset backed securities SOURCE: Selling of fund shares
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Problem of Book Value Accounting

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Discussion Case: Limitations of the Balance Sheet Historical Cost versus Current Market Value Accounting

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Balance sheet figures are based on historical costs instead of current market values. This comes from the cost principle of accounting which states that, values on the balance sheet should be recorded on their original cost.

>For example, if an equipment is purchased for $5,000, it should be recorded as $5,000. No matter whether the equipment is actually worth more or less than the amount purchased. This may mislead the investors or creditors regarding the true value of the firms assets and also will cause trouble in replacement of the assets.

In order to solve this problem, on October 1979 the Financial Accounting Standard Boards (FASB) issued a ruling that required large companies to disclose inflation-adjusted accounting data in addition to their traditional historical cost data. However, with the fall in the inflation rate this rule is no longer in force.

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Problem of Book Value Accounting in Banks/FIs

Assumes that all balance sheet items will be held to maturity Does not show the impact of changing interest rates and default risk etc.

Auditors do not guarantee the accuracy of earnings, but only that statements are a fair financial representation
EPS for a company is not a precise figure that is readily comparable over time or between companies

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Ethics in Banking

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Window Dressing or Creative Accounting Manipulation of Financial Statements to Look Stronger and More Successful

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