MANAGEMENT OF FINANCIAL

INSTITUTIONS

FINANCIAL STATEMENTS
OF COMMERCIAL BANKS

Professor: Senda Belhaj Slimene

JUNIOR FINANCE
COMMERCIAL
BANK
 Commercial Banks are the largest group of
financial institutions in terms of total assets
Major assets are loans
Major liabilities are depositsthus, they are
considered depository institutions
Perform services essential to financial markets
play a key role in the transmission of monetary
policy
provide payment services
provide maturity intermediation
Banks are regulated to protect against disruptions
to the services they perform

3
 Like other financial intermediaries, commercial
banks facilitate the flow of funds from savers to
borrowers.

The main characteristics of commercial banks

are as follows:

Most banks own few fixed assets, and thus

low operating leverage.
Many bank liabilities are payable on demand
or carry short-term maturities so depositors
can negotiate rates as market rates change.
As a result, interest expenses changes
coincidentally with short-run changes in
market interest rates.
Banks operates with less equity capital than
non-financial companies.
 COMMERCIAL
BANK
BALANCE SHEET
 It presents financial information comparing what
a bank owns with what it owes and the ownership
interest of stockholders.

A banks balance sheet is also a list of its bank

funds sources = LIABILITIES and uses to which
the funds are put = ASSETS

Assets indicate what the bank owns

Liabilities represent what the bank owes.
Equity refers to the owners share.

ASSETS = LIABILITIES + EQUITY CAPITAL

 If we put assets on one side of the banks balance
sheet, and liabilities plus capital on the other,
then the 2 sides of the balance sheet will always
balance.

BALANCE SHEET

LIABILITIES
ASSETS

EQUITY CPITAL
BANK LIABILITIES
AND EQUITY
CAPITAL
BANK LIABILITIES
 Bank funding sources are classified according to
the type of debt instrument and equity
component

Liabilities are the bank funds sources. Banks

obtain funds by borrowing and issuing claims
against themselves such as :

Demand Deposit, (checking accounts)

they are transaction accounts held by
individuals, partnerships, corporations, and
government that pay no interest. The
deposited funds can be withdrawn at any
time without any advance notice to the
depository institution.
 Automatic Transfer from Savings (ATS)
and Negotiable Order of Withdrawal
(NOW),these accounts are referred as
interest checking accounts. Banks requires a
minimum balance before depositor earns
interest. (NOW) accounts are available only
for non commercial customers.
 Money Markets Deposits Accounts
(MMDAs), They are able to offer a higher
interest rate by requiring a higher minimum
balance, and by placing restrictions on the
number of withdrawals the account holder
may take over a given period of time. This
restriction makes them less liquid than a
checking account, but more liquid than
bonds.
 Savings Accounts: in these accounts,
funds can be added or withdrawn at any
time without penalty, In contrast to checking
accounts, you cannot write checks and use
electronic debit to access your funds. They
are generally for money that you don't
intend to use for daily expenses. All the
account transactions and interest payments
are recorded in a passbook held by the
account owner.
 Time Deposit Accounts (Certificates of
Deposit: CDs) banks have to specify the
interest rate and the maturity date. If the
deposit is withdrawn before the maturity
date, the interest paid is reduced of the
interest penalty. They are less liquid but
earn higher interest rate. They are generally
held by individuals and businesses;
(Household/retail CDs for deposit less than
100.000 USD and wholesale/large CDs for
deposit more than 100.000 USD)
 Borrowing: the liabilities described above are all
deposits liabilities. However, banks, not only fund their
assets by issuing deposits but borrow in various markets
from Central Bank, other banks and financial
institutions.

Since the funds generated from these borrowings are not

deposits, they are subject to neither reserve
requirements nor deposit insurance premium payments
to the Central Bank

However, deposits represent more permanent and lower

cost funding
EQUITY CAPITAL
 Common Stock: Holders of common stock
exercise control by electing a board of directors
and voting on corporate policy. Common
stockholders are on the bottom of the priority
ladder for ownership structure.
Preferred Stock: holders of preferred stock
have a dividend that must be paid out before
dividends to common stockholders and the
shares usually do not have voting rights.
Retained Earnings: the banks cumulative
net income, since it started operation, minus
all cash dividends paid to the stockholders
 Bank capital is raised by selling equities (stocks)
or from retained earnings

Bank Capital is a caution against a drop in the

value of its assets, which could force the bank
into insolvency meaning that the bank can be
forced into bankruptcy (it owes more than it owns
or it can repay)
 BALANCE SHEET
ASSETS LIABILITIES AND
EQUITY CAPITAL
1/ LIABILITIES
A/ Deposit:

Demand Deposit
ATS and NOW
Money Market Deposit
Accounts (MMDA)
Savings
Time Deposit (CDs)

B/ Borrowed Funds

2/ EQUITY CAPITAL
BANK ASSETS
 The Bank uses the funds collected from borrowings,
deposits and equity capital to turn them into assets

Banks assets fall into one of 4 general categories as

follows:

Loans

Investment securities

Cash and Due from Institutions

Other Assets
LOANS
 Loans are the major asset in most banks
portfolios and generate the greatest amount of
income before expenses and taxes but exhibit the
highest default risk

The bank negotiates loan terms which vary with

the use of proceeds, repayment modalities and
type of collateral

The interest rate can be fixed over the life of the

loan or variable depending on changes in interest
rates of the market

Loans are less liquid than the other assets,

 They can be classified into:

Real estate loans: they are secured by

real estate and generally consist either of
property loans or interim construction loans.

Commercial Loans which consist of

commercial and industrial loans, loan to
financial institutions, and obligations to
state and political subdivisions.

Individual Loans include those negotiated

directly with individuals for household,
family and other personal expenditures.
 Agricultural Loans which are directed to
finance agricultural production and other
loans to farmers.

Loans in Domestic Offices include all

other loans and all lease-financing
receivables in domestic offices.

Loans and Lease in Foreign offices, are

essentially business loans and lease
receivables made to foreign companies or
loans garanted by foreign governments.
INVESTMENT
SECURITIES
 They can be short term or long term maturity
investment

They are held to earn interest, help to meet

liquidity needs, speculate on interest rate
movement, and serve as part of banks dealer
functions.

The largest amount of these securities is

government securities (Treasury Bills, Notes and
Bonds). These securities are free default risk and
highly liquid

Some banks also hold corporates, foreign

CASH AND DUE
FROM
INSTITUTION
 They can be classified in 3 categories:

Reserves = Vault Cash: are funds held by

the bank in an account at the Central Bank to
meet customers withdrawals. These reserves
are composed of required/legal reserves
(regulation authority) + excess reserves
(optional reserves)

Cash Item: funds not yet received from

another bank, they are in process of collection
 Deposits held at other banks called
correspondent banks, many small banks hold
deposits in larger banks in exchange for a
variety of services, foreign exchange
transactions,
OTHER ASSETS
 Other Assets: are residual assets of relatively
small magnitude, the depreciated value of
bank premises and equipment, other real
estate owned
 BALANCE SHEET
ASSETS LIABILITIES AND
EQUITY CAPITAL
1/ LIABILITIES
A/ Cash and Due from A/ Deposit:
Institutions:
Demand Deposit
Reserves (Vault Cash) ATS and NOW
Required Reserves Money Market Deposit
Excess Reserves Accounts (MMDA)
Cash Items in process Savings
of collection Time Deposit (CDs)
Deposits at other banks
B/ Borrowed Funds
B/ Loans

C/Investment Securities 2/ EQUITY CAPITAL

D/ Other Assets
COMMERCIAL
BANK ASSETS
 Commercial banks face unique risks because of their
asset structure
credit (default) risk is the risk that loans are not
repaid
liquidity risk is the risk that depositors will
demand more cash than banks can immediately
provide
interest rate risk is the risk that interest rate
changes erode net worth

credit, liquidity, and interest rate risk all contribute to

a commercial banks level of insolvency risk
 OFF BALANCE
SHEET ACTIVITIES
 Commercial banks engage in many fee-related
activities that are conducted off the balance
sheet:

guarantees such as letters of credit

future commitments to lend
derivative transactions (e.g., futures, forwards,
options, and swaps)
 Off-balance-sheet asset

when an event occurs, this item moves onto

the asset side of the balance sheet or income
is realized on the income statement

Off-balance-sheet liability

when an event occurs, this item moves onto

the liability side of the balance sheet or an
expense is realized on the income statement
BANK INCOME
STATEMENT
 The income statement measures bank
performance over a period of time

Interest related to accounts are shown first in the

income statement because of the financial
feature of banks

Interest income on a banks earning assets is the

primary source of bank income

Interest expense represents the cost to obtain the

funds employed by the bank and it is usually the
primary cost category.
SRTUCTURE OF BANK INCOME STATEMENT
INTEREST INCOME (1)
Securities, Loans
INTEREST EXPENSE (2)
ATS/NOW Accounts, MMDA, Savings Accounts,
Time Deposit Accounts, Borrowed Funds
NET INTEREST INCOME (3)=(1) (2)
Provision for loan losses (4)
NET INTEREST INCOME AFTER PROVISION
(5)=(3) (4)
NON INTEREST INCOME (6)
Deposit service charge, Other non interest
income
NON INTEREST EXPENSE (7)
Salaries, Premises and equipment expense,
Other non interest expense
NET OPERATING INCOME (8)=(5) + (6) (7)
is the sum of interest earned on all of
banks assests such securities and
loans
represents the second major category
on banks financial statement. It
includes the interest paid
It is an important tool in assessing
banks ability to generate profits and
control interest rate risk
Charged amount to establish a
sufficient reserve to absorb expected
loan losses. It is non cash expense but
indicates the bank management s
prediction of loan default risk for the
period
All other incomes received from on
and off balance sheet activities
Is generally larger than the non
interest income
RELATIONSHIP BETWEEN
INCOME STATEMENT
AND BALANCE SHEET
 Both sheets are correlated. The net income is
determined by the composition of assets and
liabilities and the different interest rates

This direct relationship between these 2 financial

statements can be seen by computing the net
income as follows

NI = Rn*An - Rm*Lm- P +NII-NIE-T

SRTUCTURE OF BANK INCOME STATEMENT

INTEREST INCOME (1) II = Rn*An

Securities, Loans
INTEREST EXPENSE (2)
ATS/NOW Accounts, MMDA, Savings Accounts,
Time Deposit Accounts, Borrowed Funds
Rn is the interest income rate on the
value of the nth asset (An)
IE = Rm*Lm
Rm is the interest expense rate on
the value of the mth liability (Lm)

NET INTEREST INCOME (3)=(1) (2)

Provision for loan losses (4) P

NET INTEREST INCOME AFTER PROVISION

(5)=(3) (4)
NON INTEREST INCOME (6) NII
Deposit service charge, Other non interest
income
NON INTEREST EXPENSE (7) NIE
Salaries, Premises and equipment expense,
Other non interest expense
NET OPERATING INCOME (8)=(5) + (6) (7)
 NI = Rn*An - Rm*Lm- P +NII-NIE-T

Changes in the composition or volume of assets

and liabilities will have an impact on Net Interest
Income
On the other hand any change in interest rate will
alter the Net Interest Income
TOP 5 OF LARGEST BANKS
Total
Assets
1/ Industrial and Commercial Bank of China 2954 USD Billion

2/ HSBC 2681 USD Billion

3/ Deutsche Bank 2597 USD Billion

4/ Crdit Agricol 2582 USD Billion

5/ BNP Paris 2508 USD Billion

EXAMPLE OF BASIC
OPERATIONS
 A company opened a current account and
deposited 100.000 TND. How can you write this
operation in the bank balance sheet?

This deposit shows up as a liability for the bank

It increases the bank reserves (Required

Reserves+Excess Reserves). Excess Reserves in
order to be allocated as loans, investment
securities,
 BALANCE SHEET
ASSETS LIABILITIES AND EQUITY
CAPITAL
1/ LIABILITIES
A/ Cash and Due from A/ Deposit:
Institutions: +100.00
+100.00
0
Demand Deposit 0
Reserves +10.000
+90.000 ATS and NOW
Required Reserves Money Market Deposit
Excess Reserves Accounts (MMDA)
Savings
Cash Items in process Time Deposit (CDs)
of collection
Deposits at other banks B/ Borrowing
B/ Loans
C/ Investment Securities 2/ EQUITY CAPITAL
D/ Other Assets
 A company deposited a check of 20.000 TND
written on its client account at another bank. How
can you write this operation in the companys
bank balance sheet?

This deposit shows up as a liability for the

companys bank

The companys bank didnt yet receive this

amount of money from the other bank. The
amount is in process of collection.
 BALANCE SHEET
ASSETS LIABILITIES AND EQUITY
CAPITAL
1/ LIABILITIES
A/ Cash and Due from A/ Deposit:
Institutions: +20.000
+20.000
Demand Deposit
Reserves +2.000
+18.000 ATS and NOW
Required Reserves Money Market Deposit
Excess Reserves+20.000 Accounts (MMDA)
- 20.000 Savings
Cash Items in process Time Deposit (CDs)
of collection
B/ Borrowing
Deposits at other banks

B/ Investment Securities 2/ EQUITY CAPITAL

C/ Loans
D/ Other Assets
 The Bank holds 700.000 TND as Excess Reserves.
In order to use this amount in more productive
way, It decides to allocate 500.000 TND to loans
and invest 200.000 TND in securities. How can you
write this operation in the bank balance sheet?

It is not a supplementary deposit it is just a

modification in assets allocation.

By doing so, the bank rises its income by investing

in more earning assets
 BALANCE SHEET
ASSETS LIABILITIES AND EQUITY
CAPITAL
1/ LIABILITIES
A/ Cash and Due from A/ Deposit:
Institutions:
Demand Deposit
Reserves
-700.000 ATS and NOW
Required Reserves Money Market Deposit
Excess Reserves Accounts (MMDA)
Savings
Cash Items in process Time Deposit (CDs)
of collection
Deposits at other+200.00
banks B/ Borrowing
0
B/ Investment Securities
+500.00
0 2/ EQUITY CAPITAL
C/ Loans

D/ Other Assets
 This modification in assets allocation has 2
impacts on:

The Balance sheet: Replacement of Excess

Reserves by Loans and Investment Securities
The Financial Statement: The assets
replacement by more earning ones makes the
bank rise its interest income
 The Bank borrowed 1M TND on the Money Market
and received 5 M TND deposits:
20% ATS
40% Demand depoit
30% MMDA
10 CDs

These liabilities funds was used as following:

50% loans
25% investment securities
15% cash item
5% other assets
 BALANCE SHEET
ASSETS LIABILITIES AND EQUITY
CAPITAL
+6.000.0
1/ LIABILITIES 00
+5.000.0
A/ Cash and Due from A/ Deposit: 00
Institutions: +2.000.0
Demand Deposit 00
Reserves +500.000 +1.000.0
ATS and NOW 00
+275.000
Required Reserves Money Market Deposit
Excess Reserves +1.500.0
+825.000 Accounts (MMDA)
00
Savings +500.00
Cash Items in process Time Deposit (CDs) 0
of collection
Deposits at other+1.375.0
banks +1.000.0
B/ Borrowed Funds00
00
B/ Investment Securities
+2.750.0
00 2/ EQUITY CAPITAL
C/ Loans +275.000
D/ Other Assets